We continue to expect solid growth in the US – and even though inflation has been elevated recently, the downward trend remains intact, which should motivate moderate monetary policy easing going into 2025. This cocktail should send equities further up, while bonds again offer decent value. Bo Bejstrup Christensen, Head of Macro & TAA.
At the start of 2024, we wrote that the markets had priced in slightly too much monetary policy easing in the near term, which was why short yields had fallen too far, while medium- to long-term yields were roughly fair or a tad too high.
Our call proved more or less correct, although long US yields in particular clearly rose more than we expected in Q1 2024.
We have for quite some time been focused on just how expensive the market would be capable of pricing equity risk if our expectations of a soft landing and the prospect of economic growth going forward to the second half of this decade panned out. But equities have again outperformed our expectations, which begs the question – can this really continue? Our reply is yes, but at a slower pace.
These are some of the key takeaways in our latest AM Quarterly View report from Bo Bejstrup Christensen, Head of Macro & TAA at Danske Bank Asset Management.
EQUITIES: Decent growth is a driving factor
We assess the driving factor behind the impressive rise in equities and the low level of volatility to be the market’s ongoing upward revisions to growth expectations, especially for the US.
As we continue to see decent growth both this year and next and in fact remain more positive on the US growth outlook than Consensus, this trend should continue. And given accelerating growth in the eurozone, stability in China, lower inflation and the start of modest monetary policy easing, equities in the rest of the world should also perform reasonably.
Clearly, the upcoming presidential election in the US is an uncertainty factor and will stoke volatility across financial markets as the election campaigns ramp up. But neither of the candidates will do serious damage to the US economy, so any tumult in the equity market should be temporary as long as our economic forecasts are more or less met.
BONDS: Offer decent value
The market is now pricing a more realistic path for monetary policy in 2024 in both the US and the eurozone than it did at the start of the year. However, for 2025 and beyond we now assess the market to be slightly sceptical in terms of how far the Federal Reserve may cut interest rates.
And given that strong growth data and the latest inflation figures have sent medium- and long-term bond yields further up, for the first time in a long time we now see decent value across most of the US yield curve. We therefore expect significant declines in both short and long bond yields in the US over the next 6-12 months, driven in particular by rate cuts kicking off.
In contrast, we are still of the opinion that the market is pricing in too much easing from the ECB going forward to 2025 and 2026, which is why very short bond yields do not look particularly attractive in our view. However, the rest of the eurozone curve is more sensibly priced, and we are also expecting modest declines in yields here as actual rate cuts approach in the second half of 2024.
Hence, we are now in a situation where bonds offer decent value.
EMERGING MARKETS: Short-term potential
As usual, we would emphasise the significant difference in asset classes within emerging markets. Lower global inflation and more accommodative monetary policy in the US and Europe should support bonds issued by emerging markets in both local and hard currency.
In terms of emerging market equities, we would continue to stress the long-term challenges in China as a hindrance for the market. In the short term, however, our positive global growth expectations, lower inflation and more accommodative monetary policy should support emerging market equities.
We expect equities and bonds to diversify each other better
Inflation has been higher than anticipated in Q1, 2024. However, while we have increased our inflation forecast for this year, like the Federal Reserve we consider most of the inflation disappointments so far this year to have been driven by temporary factors. This is why we have not significantly revised our inflation forecasts for 2025 and 2026.
With lower inflation ahead, the market’s ability to price significant rate cuts in the event of unexpected negative shocks to the economy should increase. Thus, recent market developments and our forward-looking macro forecasts are now compatible with stronger risk adjusted performance for the classic balanced portfolio, where diversification between equity and bond duration risk generates improved risk adjusted returns and bond duration provides solid protection against left tail outcomes in the equity space.
This material has been prepared for information purposes only and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.
