Positioning bond investments for steep rate cuts
Ariel Bezalel and Harry Richards say that the state of the global economy calls for a sharp decline in interest rates in the coming months, which could potentially benefit government bonds.
The fixed income markets have sharply repriced over the past few months, as investors believe cooling inflation and rising unemployment could prompt a series of interest rate cuts in the next two years.
The US Federal Reserve (Fed) has already kicked off its easing cycle by cutting rates by 50 basis points, joining other major central banks that have been grappling with sluggish growth. The move was spurred by macroeconomic data published during the summer, which have clearly shifted the balance of risks for monetary policy from the price stability side of the Fed’s mandate to full employment.
Fed Chair Jerome Powell has said the Federal Open Market Committee (FOMC) does not “seek or welcome further cooling in labour market conditions”, which underscores the importance the central bank attaches to the jobs data.
The unemployment rate has shown a material increase in the last 12 months. While the absolute level remains benign and not too far from what could be defined as maximum employment, the speed of increase in unemployment looks worrying and historically this has been a very good predicator of US recessions (as demonstrated by the widely discussed Sahm Rule).
US Unemployment Rate Sahm Rule* vs. US Recessions
Source: Bloomberg as at 30.09.24. *Last 3 months average unemployment rate minus minimum 3 months average unemployment rate in the last 12 months.
Private payrolls ex-Education & Health services – Contribution to total US Payroll growth in the past 12 months
Private payrolls ex-Education & Health services – 6m growth
Source: Bloomberg as at 30.09.24
US real excess savings by income quartile
The rest of the world continues to look in a precarious position to us. The recovery in the Eurozone has almost faded, with recent Purchasing Managers Index (PMI) readings showing renewed weakness. This does not look surprising. Before the pandemic, the Eurozone economy showed various signs of structural weakness, related to weak demographics and lack of competitiveness. These issues persist, and together with strong competition from China, act as a headwind for the manufacturing sector.
The UK economy surprised to the upside in the first half, but more recent data have shown some deterioration. Limited room for additional fiscal spending and rapid repricing in rates on outstanding mortgages represent key drags on the economy. Australia recorded its weakest GDP reading of the last three decades in 2Q with the exception of the Covid period. Growth in New Zealand is already in negative territory. While equity markets have been cheering the new easing cycle in China, we would argue this is a strong signal of the structural weakness in the Chinese economy.
Given the above, notwithstanding the recent rally, we continue to see value in government bonds across developed markets. Besides the US, the UK and Australia look increasingly attractive.
Corporate credit continues to look expensive, and the spreads are near all-time tights. As always, it is very hard to exactly time the moment of a spread widening. As such, given our long duration bias we still prefer to include some credit exposure across our portfolios as a diversifier and source of carry if a more benign environment for growth were to unfold. Within such credit exposure we are however very selective.
Fund specific risks
- Derivative risk – the strategy may use derivatives to generate returns and/or to reduce costs and the overall risk of the portfolio. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
- Contingent convertible bonds – The strategy may invest in contingent convertible bonds. These instruments may experience material losses based on certain trigger events. Specifically these triggers may result in a partial or total loss of value, or the investments may be converted into equity, both of which are likely to entail significant losses.
- Sub investment grade bonds – The strategy may invest a significant portion of its assets in securities which are those rated below investment grade by a credit rating agency. They are considered to have a greater risk of loss of capital or failing to meet their income payment obligations than higher rated investment grade bonds.
Jupiter Dynamic Bond Fund
The value of active minds – independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Important information
*In Hong Kong, investment professionals refer to Professional investors as defined under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and in Singapore, institutional investors under Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the «SFA»)