From Dan Farmer – CIO of MLC Asset Management
Fixed income
Market pricing of the Fed appears overdone in our central case soft-landing view, and with growth likely to re-accelerate through 2025 we see yields as close to a low end of an expected trading range. Fixed income will still provide diversification and protection against the non-central case recessionary risk, but otherwise returns will be modest.
Credit
Credit continues to offer an attractive return profile under the central case of a global economic soft-landing. This is supported by a constructive cyclical outlook, relative valuations, strong corporate balance sheets, historically high coverage ratios, and falling corporate defaults.
Very attractive yields can be found in pockets across the credit asset class spectrum (high yield, private credit, specialty finance, loans), some with duration elements and some without. The careful application of detailed borrower analysis offers the opportunity to lend capital at very attractive rates to worthy borrowers.
Interest rates: Falling short end global interest rates, but rising long end yields
Notwithstanding the potentially medium-term inflationary consequences of the coming second Trump presidency, which are likely to cause the long end of the yield curve to rise, we believe the US Federal Reserve will continue its easing cycle near term as they respond to a still fragile labour market.
Also read: Bond Markets Settled Through November
Wherever the Fed cuts to is ultimately less important than the transition to a globally synchronised central bank easing cycle and the implications this has for financial conditions. China too has recently joined the easing party with a large and coordinated stimulus package.
The main outliers are the RBA, which will likely ease at the start of 2025, and the Bank of Japan which will continue hiking near-term. Policy and financial conditions easing of this magnitude is usually enough to generate a recovery in global demand.
The US remains in the slowdown phase of the cycle. However, we have reached a critical turning point where the US economy will either move into contraction territory (and therefore recession) or move back into expansion. Our view remains that a combination of a still resilient US consumer, strong corporate and household balance sheets and a just-in-time Fed easing cycle will result in a soft-landing and the cycle re-inflecting towards expansion.
A recession is possible, but not the base case. Near term, the US economy is likely to move at multiple speeds, with interest rate sensitive sectors such as housing, manufacturing, production, and investment demonstrating signs of recovery from near-recessionary levels. On the other hand, employment will continue to deteriorate as a lag to restrictive monetary policy through 2023. Globally, the US remains the bright spot, with China still experiencing balance sheet concerns, Europe soft but recovering, and Australian domestic consumption challenged as high interest rates bite.
