Emerging opportunities for alpha in a volatile world of higher neutral rates
In a rapidly evolving global landscape, Insight Investment (Insight) presents its annual investment update for 2024, revealing key insights into the complex environment and potential opportunities for institutional and wholesale investors.
2024: Navigating a complex landscape
Complexity and volatility are key elements of the 2024 investment landscape. The most important thing to look out for in 2024 is the next step of the interest rate cycle. Markets are anticipating a considerable amount of easing in 2024 and 2025 following an extremely aggressive hiking cycle through 2022 and 2023.
Thus far, interest-rate cycles have been relatively uniform across the developed world, but we see greater divergence ahead. Australian households have historically been more sensitive to movements in interest rates than some developed counterparts, for example the US. This will become increasingly apparent as the long and variable lags from changes in monetary policy begin to fully impact these economies.
Rate cut predictions: Are markets overly optimistic?
Insight expects inflation to remain above target levels and therefore that the neutral interest rate will remain higher in coming decades. Markets may be overly optimistic in expectations of rate cuts, and some are likely to face disappointment, but bond markets don’t need aggressive rate cuts to perform well.
In this economic environment characterised by high interest rates, government bonds are once again being recognised for their diversification properties. It is possible that central banks may ease later and more gradually than is currently being priced in by markets and shorter-duration positions could leave a
portfolio exposed to pricing risks. However, in our view, bonds in longer maturities appear close to fair value and offer attractive absolute yields, which can be further enhanced by investments in investment grade credit.
Bond markets: Asia is the place to watch
The economies of China and Japan are likely to play a role in the direction of global bond markets in the years ahead. China has been a key exporter of disinflation and with a producer price index in negative territory, investors will be watching for a potential further disinflationary pulse from China, albeit the impact of this exported disinflation is likely to be much smaller than it has been in the past. In Japan, if the central bank hike rates the yield curve will likely steepen, potentially attracting the attention of domestic investors who have deployed considerable capital around the world in the search for yield. Global fixed income markets have done little to price the risk of a significant return of capital to Japan and may therefore be impacted by this shift. This could become a key theme in 2024.
Global credit: Opportunities for alpha in a volatile world
Credit cycles have turned. We are now living in a more supportive environment for credit spreads, leaving behind below-trend growth, above-target inflation, and tight monetary policy. Volatility is presenting an opportunity for alpha in active strategies, making risk assets, and by extension credit markets, more attractive. Although spreads are no longer cheap, the absolute level of yields have risen dramatically over recent years, while the risks needed to generate target returns have fallen substantially.
