At the moment, the main ones central banks they are preparing for an imminent rate cut: the European Central Bank will almost certainly cut rates in June and the Bank of England will probably follow suit. However, despite central banks contesting this, it is difficult to think of rates paths outside of United States will not be affected by the action, or inaction, of the Federal Reserve in the coming months, given its impact on financial conditions, commodity prices and currency movements.
What we really need is that the slowing growth in the United States continue. This would pave the way for the Fed to reduce rates later in the year.
Increase confidence in a soft landing
In the last month we have reduced the risk of a “no landing”increasing the probability of a “soft landing”our baseline scenario, given the first signs of moderation in the US economy and better news on the inflation front.
The decline in data affected the various sectors in a transversal way economic indicators. There consumer confidenceThe job abandonment rate and the initial unemployment claims seem to suggest that some of the concerns about overheating in the labor market may have been overstated. Non-farm payrolls were primarily driving the trend, while the slower pace of hiring in “core” areas in the private sector, excluding healthcare, was a positive sign in the latest report. With growth of nearly 100,000 core jobs and 175,000 total payroll increases, the job market remains healthy.
As regards theinflationas geopolitical tensions ease, i oil prices they have fallen from last month’s highs. Meanwhile, April data onconsumer price index (CPI) in the United States showed a further improvement compared to March, especially in core areas, such as services, excluding the residential sector. With core inflation rising nearly 0.3% month over month, the absolute level remains too high for both the Fed and the market, but the improvement over the first quarter is an important step in the right direction.
If this weakening continues, it would pave the way for the Fed to begin a rate-cutting cycle later in the year.
A fact that is difficult to explain
However, during April a phenomenon occurred which is difficult to explain: the latest data from theISM survey on services was negative. It fell below 50 for the first time in over a year, with weak data on new orders, employment and production. For reasons not immediately apparent, this powerful leading indicator has become less reliable in the post-Covid era.
It’s too early to raise the risk of a hard landing. However, our scrutiny of service sector data, both official and survey-based, will be even more intense than usual in the coming months.
The implications for bond investments
Our expectations for global bond markets have improved as the likelihood of a ‘no landing’ scenario, in which bond yields would suffer more, has reduced. Furthermore, the latest Fed meeting put to rest the growing discussion about the possibility of further hikes if data remains strong, a crucial development. All of this justifies an increasingly positive stance on global duration, or interest rate risk.
Our asset allocation remained relatively unchanged compared to last month. The only noteworthy change was a slight upgrade in emerging market local currency debt. We maintain a positive view on covered bonds, mortgage-backed securities (MBS), European investment grade credit and shorter-dated quasi-sovereign issuers, while we are underweight US investment grade and high yield bonds globally, due to the unattractive ratings.
*Head of Global Unconstrained Fixed Income, Schroders
