Michael Grady

Aviva Investors, the global asset manager of Aviva PLC (‘Aviva’), expects a steady process of rate cuts from the world’s major central banks this year as global growth remains stronger and inflation somewhat more persistent than expected, according to the firm’s latest quarterly House View.

The asset manager predicts that global growth will be around 3 per cent across 2024. Whilst this is still down from 3.25 per cent in 2023, this is an upwardly revised estimated from the 2.75 per cent that was predicted at the start of the year. This is the result of Q1 2024 seeing growth momentum maintained or moderately improved across most regions. For the United States that has resulted in a better-than-expected start to the year, with consensus growth forecasts revised up for the year as whole.

In the Eurozone, growth is expected to return in Q1 following a year of stagnation. With the effects of higher energy prices fading, an historically low unemployment rate for the region and elevated household saving, there is scope for consumer spending to improve. Similarly, in the United Kingdom a return to growth in Q1 is anticipated, albeit with a slower rate of improvement this year, with ongoing headwinds from higher mortgage costs.  In Asia, the growth outlook remains positive in Japan, although 2024 is expected to be slower than 2023 due to the boost from Covid re-opening earlier last year.

As a result of the growth outlook, while rate cuts are indeed coming into focus, the pace is likely to be steady, rather than rapid. Since the start of the year the market has pushed back the likely timing of the first rate cut and seen the terminal rate of the cycle revised higher. Aviva Investors agrees with that direction of travel for the US and believes there could be a further move that way. However, pricing for the UK has been dragged along with the US, when in fact the economic backdrop looks quite different. As a result, the Bank of England could cut rates sooner and more deeply than is currently priced.

The ECB has been fairly clear that it expects a first rate cut to materialise in June, with the pace of cuts likely to be at a quarterly frequency thereafter. It is expected that the recent policy shift from the Bank of Japan will end yield-curve control (YCC) and raise the policy rate into positive territory, but further rate hikes are likely to come slowly.

Regarding asset allocation, the impending rate cuts, alongside robust corporate earnings, should result in a supportive environment for risk assets. As such, Aviva Investors continues to  be overweight equities, with a relative preference for the US and Japan over Emerging Markets. Returns have been strong this so far year, and whilst this was expected, it seems unlikely there will be a similar pace of equity market returns for the remainder of the year.

However, the team do note that the risk of market ebullience breeding instability is growing. Therefore, the team also prefer to be overweight government bonds to give balance to the asset allocation in the event of a risk event materialising. A more elevated yield environment also makes for a more attractive risk/reward dynamic as we enter a cutting cycle. The preferred markets to be overweight are the UK and the Eurozone, with an underweight in Japan. The team also continue to prefer to be broadly neutral on corporate bonds, with the risk/reward somewhat better in high-yield than investment-grade given the stage of the cycle.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “The start of 2024 has been stronger for markets than initially predicted, particularly in the US, with consensus growth forecasts moving upwards, and the expectation of a return to growth in o the UK and Europe over Q1.

“Rate cuts are certainly on the horizon, and at this time it seems like the ECB will be the first to move, potentially as early as June. However, the Bank of England has the potential to surprise markets by cutting rates earlier and more deeply than what is currently being priced.

“As a result, we expect risk assets to be in focus over the coming months. Whilst global growth figures may well end up being below the levels of 2023, the stronger than expected start to year, twinned with an impending cutting cycle could present a positive backdrop over equity markets over the remainder of 2024.

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Michael Grady

Global economic activity has proved stronger than seemed likely at the start of the year, given the scale of supply-side shocks that had fuelled inflation and eaten into disposable incomes over the previous 12 months. Several indicators suggest growth accelerated in the first half of 2023 as a drop in energy prices lowered headline inflation.

However, Aviva Investors, the asset manager of Aviva plc, believes that the current economic cycle is likely nearing its end. Even though energy prices have fallen sharply, leading central banks have not yet won their battle to control underlying inflation. That suggests interest rates will continue to rise.

This ‘late-cycle’ environment could persist for a while longer, should the global economy continue to defy expectations with its unexpected resilience. All the same, major developed economies still look set for below-trend growth in the second half as the impact on household finances of higher rates saps spending.

Central banks are striving to tighten monetary policy sufficiently to weaken labour markets, deliver softer wage growth and ultimately lower core inflation without causing an economic downturn. However, it is important to recognise such periods usually end with too much policy tightening and recession.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Returning inflation to central banks’ targets in a way that minimises economic damage is proving challenging, although some progress is being made. It still remains to be seen how much pain will be required to get inflation back to targets of around two per cent. But policymakers are mandated to deliver low inflation and they need to stay the course, even if that means parts of the economy suffer.

“Most equity markets have risen by between ten and twenty per cent this year as investors have sensed that interest rates were close to peaking, and that global economic growth was holding up better than expected. Company earnings, which have tended to surpass expectations, have also helped demand. In the short-term, we are optimistic on equity markets’ prospects, particularly in Europe as earnings are expected to hold up better and valuations are more attractive. But we are more cautious further ahead given the risk of recessions.

“The outlook for government bond markets looks more favourable than three months ago given the extent to which further interest rate increases have been priced in. The obvious, and increasing, danger that higher rates eventually tip economies into recession means we are now overweight the asset class. We see potential opportunities in the US since US interest rates are probably closer to peaking, while UK gilts are in a similar position given a further aggressive hike in interest rates is priced in. Emerging-market debt, denominated in local currencies, may also offer opportunities given the likelihood some central banks will start cutting rates in the second half.

“We are neutral on corporate bonds. The extra yield relative to government debt looks fair given healthy corporate profits and low default rates. But expectations a recession will be averted has led investors to bid up the price of corporate debt.

“We remain overweight cash. Although real rates of interest are negative, there is a prospect of earning a positive rate of return in the not-too-distant future as inflation falls and central banks continue to raise rates.”

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Michael Grady

Aviva Investors, the global asset management arm of Aviva PLC (‘Aviva’), has revised growth projections marginally higher on the back of more resilient activity data in early 2023, according to the firm’s latest quarterly House View.

However, it has cautioned that risks remain tilted to the downside, especially in some of the major developed economies. While energy prices have fallen back, the conflict in Ukraine still has the capacity to provide negative shocks. Meanwhile, the full impact of monetary tightening has yet to be felt and although peaks in policy rates are close, we may not be quite there yet.

Despite recent events, Aviva Investors does not believe recent banking troubles are comparable to the situation in 2007/8, with banks far better capitalised overall and there being no equivalent credit bubbles. The latest failures in the sector are more likely a reflection of management quality rather than representing a systemic risk to the global financial system. They do, however, show that higher interest rates will expose vulnerabilities and more may yet be revealed.

Elsewhere, Aviva Investors expects mild recessions to remain possible, but these are likely be short-lived given that private sector balance sheets are in good shape, negating the need for an extended remedial period. However, unless underlying inflation starts to return more convincingly towards target, the period of demand restraint may need to be harsher or longer, implying that central banks will need to keep policy in restrictive territory for longer too.

There is an expectation that headline inflation will fall significantly further in coming months, with core inflation to move down also, albeit at a slower pace. Risks are skewed to the upside. Central banks will remain cautious and watchful until or unless this happens more convincingly, but they will also be monitoring financial conditions more generally. These conditions tightened in the wake of banking wobbles, leading to a downward reassessment of policy rate peaks.

Uncertainties implicit in this macro backdrop mean that financial market volatility is likely to remain elevated. Turning points in the cycle are always associated with such uncertainty, but recent experience has been for this to be especially fast-paced and rapidly changing. In these circumstances it is appropriate to adopt a cautious investment approach until there is greater clarity.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Following a decade or more of near-zero interest rates and quantitative easing, it should not come as a great surprise that some were unprepared for a higher rates environment. Financial sector balance sheets are more robust than in the lead-up to the GFC, with regulators requiring much greater capital and liquidity buffers for banks. Beyond this, some important rules and “plumbing” improvements ought to stabilise “shadow banks” as well.

“However, confidence can quickly evaporate. In a world of digital banking, deposits can run much more easily than in the past. We therefore remain cautious about the near term, with financial stability risks at the forefront of the mind. 

“It is because of the rapid recovery from Covid, aided by fiscal stimulus and compounded by the hit to supply, that central banks found themselves having to deal with excess demand and inflation way above target. The objective of raising rates is not to cause financial distress, but rather to temper demand across the economy in the short term and ensure a sustainable long-term growth and inflation outcome.

“We have no misgivings about not having many high-conviction tactical or structural asset class views at present, apart from keeping cash levels high. Equities and credit have repriced through 2022, and rate cuts might eventually be appropriate. But for now, inflation is keeping policymakers hawkish, and some loosening is already priced in, keeping us neutral on government bonds. We are broadly neutral on the dollar, but any growth slowdown would still prove a challenge for EM FX.”

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Michael Grady

Aviva Investors, the global asset management arm of Aviva plc (‘Aviva’), expects most developed economies to experience recessions over the coming year, as global central banks continue to tighten monetary policy in order to address persistently high inflation. Reducing inflation is policymakers’ priority and economic slowdown or recession is considered a price worth paying.

The extent of downturns should however be modest, as private sector balance sheets are robust meaning there is no need for significant de-leveraging and retrenchment. But growth risks remain to the downside, especially over winter months as the impact of high energy prices and restricted supply is felt, especially in Europe.

The effect of the major supply-side shock following Russia’s invasion of Ukraine is still being felt, but central banks now feel they must restrict demand growth to the pace of constrained supply to counter the more underlying inflation impulse that is now compounding the impact of the energy price spike alone.

The combination of slowing growth, high inflation and aggressive central bank policy is a difficult one for financial markets. Aviva Investors believes that inflation should fall back next year, but risks are to the upside. Markets can be expected to remain volatile until underlying conditions switch more decisively towards normality.

Michael Grady, Head of Investment Strategy and Chief Economist at Aviva Investors, said: “For asset markets that had become used to cheap money and unlimited liquidity, a challenging period of adjustment to the new regime will be necessary. This will take some time to play out, although there can still be investment opportunities while it does.

“We have a preference to be modestly underweight duration, with upside inflation risks outweighing the downside recession risks. We are broadly neutral equities, with the rise in real yields putting further pressure on multiples. We also expect to see downward revisions to earnings expectations in coming quarters.

“We are neutral on credit, where we think the pricing of high yield spreads fairly reflects recession risk, although the bias is still for further widening from here. The all-in yield on investment grade paper makes it relatively attractive. In currencies, we continue to prefer to be overweight the US dollar due to greater economic resilience and higher underlying inflation in the US.”

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Michael Grady

Aviva Investors, the global asset management arm of Aviva plc (‘Aviva’), expects global growth to slow to a below-trend pace over the next year and a half, with the risk of recession rising close to 50 per cent. But the absence of major imbalances and excesses that have characterised previous downturns imply that economies should be able to rebound quickly.

The global economy is still juggling with a potent combination of supply-side shocks (including the ongoing conflict in Ukraine), tightening financial conditions and the highest inflation for a generation. These are creating considerable uncertainty and volatility in financial markets and are unlikely to be resolved any time soon.

Central banks in developed economies have either raised policy rates already or signalled their intention to do so. All are increasingly focused on high inflation and the threat it represents for macroeconomic stability. Most have concluded  that the low inflation backdrop of the last 15 years is probably now over. Taming inflation is now the priority, even if that has an adverse impact on growth over the shorter term.

Inflation should fall back later this year and more convincingly in 2023, but upside risks remain as earlier headwinds to price increases become tailwinds: unwinding of globalisation, geopolitics, global supply chains shifting closer to home and climate change policies.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “The new macroeconomic environment, the monetary policy response to it and the changing views on a range of longer-term structural factors have resulted in an extremely challenging year in financial markets.

“The heightened uncertainty around the outlook has increased both implied and realised volatility across all asset classes. As such, we prefer to have relatively light exposure at this time. We continue to have a preference to be modestly underweight duration, with upside inflation risks outweighing downside recession risks.

“Given the sharp fall in equity multiples this year, we prefer a small overweight to the asset class, apart from in Europe, where growth risks are more pronounced. We prefer to be neutral in credit, where the pricing of spreads fairly reflects recession risks. In currencies, we are long the US dollar against the Euro, given the relative outlook for the two economies.”

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Michael Grady

Aviva Investors, the global asset management business of Aviva plc (‘Aviva’), expects global growth to slow in 2022 but remain robust. World GDP growth is likely to be around four per cent this year and just above three per cent in 2023.

Post-pandemic catch-up should continue, but the outlook has been significantly clouded by the Russian invasion of Ukraine. This has also exacerbated the spike in energy and commodity prices. The economic damage will be greatest in parts of Europe. The geo-political backdrop has been changed permanently by Russia’s actions and there are clearly greater dangers of an uncomfortable division of factions across the world. How China positions itself will be a critical element of any new world order.

High inflation is already eroding household real incomes and hurting sentiment, both of which will act as a brake on growth this year and next. Inflation is still expected to fall back later this year and during 2023, but the risk of a more damaging and lasting episode has risen. Comparisons to the stagflation of the 1970s are probably excessive, but there are some similarities.

Slower growth and high inflation put central banks in a difficult position, but most have clearly signalled a need for significantly tighter monetary policy, with the most forceful message coming from the US. Policy rates may need to move above neutral to slow growth and bring inflation back to target. This raises the risk of excessive policy-induced slowdown.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Recent events in Ukraine serve to highlight the fragility of the global geopolitical and economic order. These are likely to usher in a period of greater uncertainty, increased economic and market volatility and more challenging asset allocation decisions.

“With growth expected to remain above trend this year, and corporate pricing power seemingly robust, we prefer to be modestly overweight equities in developed markets, with a more neutral view in emerging markets. Recent spread widening in credit markets has provided an opportunity to move from a preferred underweight to neutral.

“With positive inflation surprises more likely and policy rates rising significantly to address overshoots, inflation risk premia need to be higher, while real rates need to adjust to slow growth. As such, we prefer to be underweight duration.”

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Michael Grady

Aviva Investors, the global asset management business of Aviva PLC, sees a potent combination of economic drivers underpinning a strong global recovery in 2021, resulting in an above-consensus outlook for growth.

Although uncertainties remain, the COVID pandemic is passing, and successful roll-outs of vaccination programmes are allowing economies to reopen. Pent-up demand, large savings buffers and ongoing fiscal and monetary policy support will all help boost the recovery.

Despite worries about virus mutations and renewed lockdowns in a number of regions, businesses and households have shown themselves to be impressively resilient and resourceful. Successive waves of the virus have had less impact on real economic activity as both have adapted to sometimes rapidly changing circumstances.

Monetary policy is expected to remain supportive throughout 2021 and 2022, with recent changes in approach to meeting their inflation objective allowing central banks to keep policy looser for longer. The COVID reset has helped fuel major changes in the fiscal environment, with many countries shifting to bolder and larger interventionist demand management policies. The US is in the vanguard of such changes.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Given our strong growth expectations, as well as the balance of risks, we prefer to be overweight global equities, especially in US and UK markets. We are modestly underweight emerging market equities because of the anticipated headwinds from higher US bond yields, weaker local currencies and tighter domestic monetary policy.

“Higher sovereign bond yields largely reflect the brighter economic outlook as well as increases in public borrowing. Central banks maintaining rates near the effective lower bound will keep the short end of yield curves anchored, but there is scope for longer-term yields to rise further. As a result, we prefer to be modestly underweight duration.

“The upside from tighter credit spreads appears to be more limited, given the narrowing that has already taken place, so we prefer to be slightly underweight. We are mostly neutral on currencies, with the previous mildly negative view on the US dollar now more nuanced, given the more rapid growth trajectory expected there compared to other regions.”

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Michael Grady

Aviva Investors, the global asset management arm of Aviva PLC, expects the economic recovery that began in May to continue in the rest of the year and into 2021. Although further waves of COVID-19 virus infections have emerged, they should be successfully countered by limited and targeted restrictions on activity, avoiding the need for the re-imposition of full national lockdowns.

As a result, downside risks to activity have diminished since the summer, while the upside case would be further enhanced by the eventual development and distribution of effective vaccines in early 2021, alongside extensive monetary and fiscal policy support. While there is considerable uncertainty about timings, the contours of a post-COVID “new normal” should come into sharper focus in coming quarters.

The ongoing economic revival will rely on continuing policy support in the form of loose monetary policy – conventional and otherwise – and generous fiscal support and stimulus for both businesses and workers. If sustained, the combination of loose monetary policy – which is increasingly geared to achieving higher inflation than in the past decade – and expansionary fiscal policy has the potential to bring long-lasting material changes for economies and global financial markets.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “The combination of brighter economic prospects, receding risks from COVID-19 and continued policy support, has led us to take a more positive view towards risk assets. We prefer to express more risk in credit markets, with an overweight view in global high yield and US investment grade credit. Our previously negative view on global equities is closer to neutral overall.

“Relative valuations and the form of the cyclical recovery favour Europe and Emerging Markets over the US and Japan.

“The decline in sovereign bond yields globally makes them less attractive, especially as an effective risk-reducing asset in our portfolios. While we have a neutral view overall, we balance overweights in the US, Italy and Australia with underweights in core Europe.

“Arguably the most significant change in our asset allocation view has been to move to an underweight position in the US dollar against key G10 currencies, where we prefer to be overweight both the Euro and the Yen.”

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Michael Grady

(Sydney) Aviva Investors, the global asset management arm of Aviva plc, expects economic activity to continue to revive in the second half of the year, as lockdown measures imposed to inhibit the spread of the COVID-19 virus are gradually eased. But the path back is unlikely to be smooth and the pattern will vary across countries and regions. Renewed outbreaks may need to be countered by the re-imposition of some restrictions.

Weakness will be concentrated in Q2, which could see falls in GDP of between 10% and 20% in the major developed nations. The rebound that began in May will be reflected in Q3 data, when output and demand are set to rise by 5% to 15%. Although this can be described as “V-shaped”, pre-COVID levels of activity are unlikely to be reached until the middle of next year.

Despite the uncompromising monetary and fiscal response, there will likely be some permanent damage and loss, the exact scale and scope of which will not become apparent for some time. In addition, attitudes and behaviours may be different in the future because of the pandemic.

Conditions continue, therefore, to be challenging and investment strategies should aim to preserve capital and guard against downside risks. But they must also try to identify opportunities for a post-COVID world where good quality assets have been over-sold.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “We prefer to be modestly underweight global equities because of stretched valuations and elevated risks to the economic outlook. Our overweight position in credit is based on relatively more attractive valuation metrics, as well as being supported by central bank purchases.

“Within credit, we have a preference for US and European investment grade. In the sovereign space, we are modestly overweight, with a preference for the US where there is scope for further yield declines. This is partly balanced by an underweight in core European markets, although we also have a small overweight in Italy, which should benefit from positive developments in the EU Recovery Fund and other policy initiatives.”

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The exact scale of the contraction is impossible to forecast with any accuracy given uncertainty around the evolution of the spread of the virus, the way in which governments and individuals respond to that through social distancing, the economic implications and the monetary and fiscal response to alleviate the situation. However, a decline in global activity of between 10 and 20 per cent in the first half of 2020 is plausible. While risks are tilted heavily to the downside in the short term, activity is expected to begin recovering quickly in late-2020 and early 2021.

The unprecedented monetary and fiscal policy response is a collective attempt to minimise lasting damage from the lockdowns and to try and ensure that resources can be redeployed when activity recovers; hopefully in the second half of 2020. But they can only cushion the blow – there will inevitably be some longer-term impairment.

In such challenging conditions, our investment strategies should aim to preserve capital and look for opportunities where balance sheets are strong and where good quality assets have been oversold.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “We have increased our preference to be overweight government bonds, reflecting our view central banks will continue to act to maintain easy monetary conditions, and at the same time allow fiscal space to be created without higher yields. Our modest underweight equity allocation reflects our concern that economic weakness will translate into historically weak corporate earnings in 2020, which we do not think markets are fully discounting at this time.

We have moved to a more cautious stance in our currency allocation, with a preference to be long Japanese yen and short other Asian currencies. We have a neutral view across credit, where corporate bonds spreads have widened sharply, but where there is now significant support from central bank asset purchase programmes.”

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