The Fed and the ECB will have to maintain their tight monetary regimes for longer. In the absence of an unexpected recessionary dynamic, decisive central bank rate cuts are therefore unlikely in the first half of 2024. Following the sharp rise in government bonds, we have decided to reduce our allocation from "Overweight" to "Neutral". We expect equity market volatility to rise again as the outlook for economic growth deteriorates. In our sector view, we upgrade utilities to "Overweight".
For our final House View of 2023, we look at the same themes that have driven our views in recent months: inflation, yields and the regular shift in narrative. This year has largely been about inflation peaking and whether the peak is behind us. The latest US inflation numbers have been on the soft side, and this has triggered another narrative shift. It led to a sharp rally in government bonds and equity markets.
As the data dependency around inflation expectations remains important, we focus our macroeconomic article on the inflation cycle. While recent data in both the eurozone and the US suggest that inflation is falling faster than expected, it is too early for central banks to declare victory. In Europe in particular, the base effect will start to work against the European Central Bank’s target of bringing inflation back below 2%.
In our Investment Strategy, we also discuss market developments and their implications for the Federal Reserve (Fed). While market dynamics tightened financial conditions in October, helping the Fed in its fight against inflation, the recent rally has eased monetary conditions, a development the US central bank is unlikely to welcome. On the asset allocation side, however, we have decided to move our recommendation from “Overweight” to “Neutral” following the strong rally in government bonds.
This shift in our government bond position is discussed in more detail in our fixed income view. At these yield levels, we still have a positive structural bias towards government bonds, but the speed of the rally and increased interest rate volatility suggested a tactical move to “Neutral”.
Finally, on the foreign exchange side, we take a closer look at USD/JPY. The Bank of Japan’s latest adjustments, i.e. a slightly more hawkish stance with the end of daily interventions to control the yield curve, would suggest a potential stabilisation of the pair around 150 yen or even slightly lower. This would be even more the case if the Fed is finally done raising interest rates.
Monthly inflation rates, which avoid the base effect noise of year-over-year inflation, continue to be above levels consistent with the 2% inflation target of the Fed and the ECB. This suggests that both central banks must continue their tight monetary regimes for longer. In the absence of unexpected recessionary dynamics, decisive central bank rate cuts are therefore rather unlikely in the first half of 2024.
Following the sharp rise in yields, we have decided to reduce our allocation to government bonds from “Overweight” to “Neutral”. We still think government bonds are attractive from a strategic perspective, but the recent rally has been so rapid that a neutral stance seems more appropriate from a tactical perspective.
Based on a pessimistic investor sentiment and oversold levels, a moderate easing of monetary policy conditions sparked a rebound in the equity markets. We expect volatility levels to rise again in view of gloomier economic growth prospects. In the Swiss equity market, which has lagged significantly, as well as in the capital-intensive utilities sector in Europe we see relative catch-up potential. In our sector view, we therefore upgrade utilities to “Overweight”.
Following the sharp decline in long-term government bond yields in recent weeks, we believe a temporary countermovement is likely. In terms of our current positioning, this means that we are taking advantage of the recent rally to reduce our position in government bonds to “Neutral”. With the exception of the high-yield segment, where we avoid the financially weakest issuers, we are currently “Neutral” in all other fixed income segments. What remains constant are our preferences within these segments. In credit, for example, we favour shorter-dated bonds from investment-grade issuers, while in government bonds we continue to focus on longer-than-average maturities.
The fate of the Japanese yen is closely linked to the Bank of Japan’s policy. Recently, there have been shifts in line with our expectations of necessary adjustments that could help stabilise the USD/JPY exchange rate. It is conceivable that the the currency pair may trade moderately lower from here, also given the psychological threshold of JPY 150 on the upside. That being said, a significant portion of this equation rests on developments in the United States.
Despite several geopolitical crises, the gold price has not risen significantly. Moreover, we believe that the sidewards trend that has been developing since the peak in May at around USD 2 050 per ounce remains intact, provided that the conflict in the Middle East is not escalating. However, gold is holding up well with higher real yields and a stable US dollar.