The Franklin Templeton Fixed Income team has issued its fourth-quarter 2023 outlook, ahead of the US Federal Reserve’s policy decision.
The Franklin Templeton Fixed Income team conducts a team-wide quarterly research and strategy Forum driven by independent macroeconomic, fundamental sector, and quantitative research, to explore and collaborate on economic and investment outlook. These fixed income views reflect the outcome of this investment forum.
The Franklin Templeton team has, since the last quarter, upgraded their view on both the US and euro area (EA) economies, and are no longer projecting a technical recession in the former.
“Where we break from market consensus is in our view on the US Federal Reserve’s (Fed’s) path to monetary policy normalization. The market appears to be confident in the Fed’s ability to orchestrate a “soft landing” that would allow the Fed to cut interest rates throughout next year.
“We feel the trajectory of disinflation in both the United States and EA will flatten—and central banks are thus likely to keep rates higher for longer. Spreads in fixed income sectors are pricing in a quite sanguine environment, with levels leaning toward long-term averages, much tighter than previous periods of stress. We retain the view that both active portfolio management and superior security selection will be the main drivers of returns for investors.”
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The team notes, “Although there have been several bumps along the way, fixed income spread sectors, almost without exception, have benefited from improved risk appetite as they have posted strong excess returns year-to-date.
“We have witnessed higher spread volatility, but so far this year, spreads have trended tighter. Better-than-forecasted global economic conditions have blunted concerns as to the impact slowing economies will have on fundamentals, whether in the corporate credit, emerging market (EM), or US housing sectors.
“In our view, the market has moved too far in many sectors, pricing in a near-perfect economic landing without any major worries over issuers’ fundamental positions. This has led to an asymmetric risk profile in which there does seem to be room for further tightening, and there exists the potential for a selloff on any adverse news.
“However, we are finding value in certain select positions in EM and high-yield corporate debt that our dedicated credit analysts have selected which have strong risk/reward profiles.
“As we have witnessed over the past year, investors seem willing to withdraw funds from fixed income sectors on bad news in fear that they will be the last one out the door. While most fixed income spread sectors appear to us to be fairly valued, we do see some pockets of opportunities.
“Focusing on higher-rated, lower-duration assets will allow us to take advantage of strong interest-rate carry, potentially adding to our performance without exposing the portfolios to unwanted spread widening risk.
“We also look to use our duration positioning as a hedge against widening spreads.
“Regarding foreign exchange (FX), we maintain a relatively neutral position in the US dollar, reflecting the mature state of the country’s monetary policy cycle.
“In our view, the euro will likely appreciate over the medium term considering ongoing central bank policy tightening, and conversely, we feel the Japanese yen will continue to struggle given the BoJ’s slow response to persistent inflation.
“As we navigate through the upcoming developments in the economy and Fed policy, we believe there will be better entry points in some sectors to add to risk, and, therefore, we have maintained our overall risk outlook as neutral with reasons for concern.”
