Markets remain hopeful for a rate cut this fall as economic indicators continue to signal easing on inflationary pressures. For bond investors looking to the near- and longer-term, Matt Eagan of Loomis, Sayles & Co. stepped through considerations and opportunities in a global fixed income market outlook.
Looking Beyond the Next Few Months
The fiscal deficits many central banks carry could create long-term inflationary pressure, according to Matt Eagan, CFA, head of the full discretion team and portfolio manager at Loomis, Sayles & Co, in a recent video. These deficits, driven by demographics, government spending, electrification, and more, are structural.
“These are the things that I think are going to keep tailwinds for inflation and keep both real rates higher and inflation premiums higher as we go through various cycles,” Eagan explained.
In the short term, Eagan believes inflation will continue to decline, with year-over-year CPI falling to 2.75% in the U.S. This, in turn, enables the Fed to cut rates beginning this year and potentially into next year. Eagan forecasts a longer-term interest rate between 3.5% and 3.75% in the U.S.
“With the combination of those structural and cyclical themes, what it means is we’ll see a shallow rate-cutting cycle,” explained Eagan. This, in turn, will cause the yield curve to steepen, with yields declining on the front end while the long end remains relatively range-bound.
The U.S. central bank policy is likely to join other central banks in cutting rates this year after diverging for much of the last two years. While rising rates and continued economic performance boosted the dollar’s strength, falling rates will likely bring it back in line with its more historical trend. A weakening U.S. dollar will also bring overseas markets back into focus for bond and equity investors.
“I think the best days for the dollar are behind us from… a cyclical perspective,” Eagan said. “We expect the dollar not to really trade off significantly but to at least have its upside capped here and maybe trend down a little bit lower.”
A Look at Credit Markets
Despite high inflation and rates, many corporations are in relatively healthy positions today. That’s in large part due to their ability to rely on previously locked-in, lower interest rate loans. This has resulted in many companies still being able to improve their credit in the last two years, albeit at a slower rate than previously.
“Corporate profits have remained very resilient,” Eagan noted. Companies have “passed through many of those prices and inflation back to the consumer and then maintained margins.”
This resulted in tightening credit spreads, particularly in the wake of the Fed pausing rate hikes last fall. While tighter spreads lead to higher prices, Eagan quickly notes that the likelihood of credit loss remains muted. “I think we’re in the trading range environment [where]the technicals are keeping spreads on the tighter side.”
This is in large part due to heightened demand meeting reduced issuance. This creates an environment in which investors can seek out targeted opportunities while still earning carry.
Elections and Bond Investment Opportunities
This year also brings with it several elections globally. Surprises in recent elections in Mexico and Europe led to enhanced local market volatility. While the U.S. election results may also lead to market volatility, it does little to change the fiscal deficit’s bigger picture.
“It depends on how and in what ways that money is being spent,” explained Eagan. Whether “for tax cuts versus investment, that’s the big question mark.”
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