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2024 Will Bring Opportunities in Fixed Income: Morgan Stanley
In its 2024 investment outlook, Morgan Stanley shared why it’s bullish on fixed income. A major reason is that it expects for inflation to continue moderating. Within fixed income, the bank likes high-quality bonds and government debt from developed markets. In terms of equities, it sees less upside given that markets have already priced in a soft landing.
According to Serena Tang, Chief Global Cross-Asset Strategist at Morgan Stanley Research, “Central banks will have to get the balance correct between tightening just enough and easing quickly enough. For investors, 2024 should be all about threading the needle and looking for small openings in markets that can generate positive returns.”
The bank recommends a more cautious approach in the first half of 2024 as there are numerous headwinds including restrictive monetary policy, a conservative earnings outlook, and slower economic growth. However, it sees rate cuts starting in June of 2024 which should provide a boost to the economic outlook in the second half of 2024 due to inflation falling to the Fed’s target.
It also expects lower levels of global growth in the US, Europe, and UK while also seeing weak Chinese growth as a risk, although it believes that the country will avoid a deflationary spiral that could have negative ripple effects for the wider region.
Finsum: Morgan Stanley shared its 2024 outlook. Overall, it’s bullish on fixed income due to expectations that inflation will continue to fall while growth will disappoint in 2024.
Rising Odds of a Soft Landing
Something has shifted in the market following the softer than expected October CPI report. At one point this year, a recession in 2024 seemed like the consensus trade, especially following the failure of Silicon Valley Bank, stresses in the banking system, and fears that high rates would choke off growth.
Now, the odds of a soft landing are rising. According to Robert Tipp, PGIM Fixed Income’s chief investment strategist, many seem to be aware of the historical context of previous soft landings. He cites 2018 and the mid-1990s as examples of rate hike cycles that didn’t result in a recession.
He believes that rising rates and tighter financial conditions are only recessionary, if economic growth is dependent on borrowing. He adds that “The excesses that would typically create a recession are simply not in existence. A lot of the expansions in the past were dependent on borrowing, but this time, it is a job growth driven organic expansion.”
In contrast to previous borrowing-driven expansions, there is much less leverage. Financial institutions remain well-capitalized, household balance sheets are in solid standing, lending standards remain high, and there are no asset bubbles in sight. Adding to this is that the economy continues to add jobs while consumer spending remains firm on a real basis.
Finsum: PGIM’s Robert Tipp believes that a soft landing outcome is likely. He points to the lack of leverage, historical instances, and firmness of the labor market and consumer spending as primary factors.
Bonds Surge Following CPI Report
Equities and bonds moved higher following the October CPI report that came in much softer than expected. As a result, traders increased their bets that the Fed hiking cycle is over, while Fed fund futures showed an increase in the number of rate cuts expected in 2024. Further, odds of a hike at the December meeting went from 21% to 0%, and the market’s consensus for the Fed’s next move is now a 50-basis point cut in July of next year.
In terms of fixed income, the 2Y Treasury note fell by 20 basis points, while yields on the long end saw similar declines. The data is also supportive that the Fed can successfully achieve a ‘soft landing’ as the economy continues to expand, while it’s managed to make significant progress in terms of battling inflationary pressures. Many market participants didn’t think it would be possible for the Fed to successfully curb inflation without throwing the economy into a recession.
Some of the key takeaways from the report were core CPI hitting a 2-year low, while headline inflation was flat on a monthly basis and up 3.2% on annual basis. Some of the biggest contributors were weakness in energy prices, shelter costs moderating, and small declines in airfare prices and vehicle costs.
Finsum: Fixed income and equities soared higher following the October CPI report which came in much softer than expected.
Don’t Be Distracted by Short-Term Volatility
The Federal Reserve is clearly close to the end of its hiking cycle. Thus, there is more data dependency which is leading to big swings in the stock and bond markets following the release of economic data such as the CPI and the jobs report. According to Blackrock’s Rick Rieder, the CIO of Global Fixed Income, many market participants are making a mistake by over reacting and losing sight of the more durable and investable trends.
There have been several instances of misleading data. For instance, the ISM hit a contractionary level of 48 in January of this year which led many to believe that a recession was imminent. This has proven to be incorrect as the economy is forecasted to expand by 2% on a real basis this year. Weakness in manufacturing has been more than offset by strong household balance sheets, wage growth, and growth in services.
Reider also believes that investors should temper their urge to make bold predictions for 2024 or the long-term given the number of unpredictable forces of a historical nature, impacting the global economy. There is a wide range of possible outcomes and major potential ramifications in terms of geopolitics and financial markets, so it’s important to not fall prey to short-term volatility.
Finsum: Blackrock’s Rick Reider shared why investors shouldn’t overreact to economic data even though this is the temptation with the Fed close to the end of its hiking cycle.
Fixed Income Issuance Set to Increase in 2024
Despite the pain and volatility of higher interest rates, fixed income issuance is continuing to expand at a healthy clip. Skeptics who are calling for the “death of bonds” are incorrect as the market continues to function well despite the bear market.
In 2022, global bond issuance was down by 20%. However, this is mostly attributed to above-average issuance during the period of extremely easy monetary policy in 2020 and 2021.
Now, fixed income sales are normalizing and forecasted to exceed $6 trillion by year-end. And issuance is set to increase even more next year. Over the next couple of years, trillions in corporate debt will need to be refinanced which will be the major driver of new issues.
On the demand side, interest in the asset class has surged due to yields at attractive levels while the economic outlook remains muddled. Many institutions are forced buyers of fixed income securities due to regulatory reasons. Additionally, proceeds from fixed income investments are also often re-invested.
Currently, the global bond market is worth $140 trillion which means that even with 2% yields, it would generate nearly $3 trillion in payments. Of course, this figure is much higher given that most yields are much higher, but it’s an indication of the bond market’s staying power.
Finsum: Fixed income deals with considerable volatility and looks set for its second straight losing year. Yet, the bond market continues to operate fine with minimal systemic risk.