Bonds finished 2023 strongly following the market categorically rejecting the 5.00% level in US and Australian 10-year bonds in October. This has provided a solid base for bonds in 2024 following the global peak in yields and the end to the global central bank hiking cycle. The market was comforted with the lower inflation readings and the weaker set of economic data. Bond supply dynamics also played a part when the narrative of increasing government deficits was alleviated with US Treasury projections in the order of 100 billion less than the market was expecting.

Markets have moved to more aggressively price in easing from the US Federal Reserve (US Fed), Bank of England and European Central Bank given declining inflation with goods inflation the driver. While time will tell whether November’s cash rate hike from the Reserve Bank of Australia (RBA) was the last in the cycle, our view is that we are either at, or at least very near, the peak in cash rates.

If history is a guide, cash rates tend to remain on hold at the peak for an average of eight months.  While this is certainly not an exact science, based on what we currently know about the economic outlook and market pricing, we anticipate that the RBA will start to loosen monetary policy in 2024 following in the slipstream of its global central bank counterparts. Predicated on this view, any back up in yields will provide a decent opportunity to increase duration exposure, particularly in the 3-to-5-year sector where historically the curve steepens as markets approach their first rate cut.

The monetary tightening has pushed the global credit impulse to its weakest level since the Global Financial Crisis, which implies weaker demand growth moving forward placing pressure on the jobs market. High delinquency rates and credit card balances currently support anemic consumer confidence and may begin testing both consumer resilience and the ability of employers to maintain employment with margins under pressure. The job market in 2024 will be the main determinant of whether we travel down the path of a ‘hard landing’ with the commensurate aggressive easing of short-term interest rates and much higher bond prices with the recent rally into year-end just an entrée to what can be served up.

Market outlook: Are recessionary signal lights still flashing red?

US recessionary indicators are all signaling a code red alert. An inverted yield curve persisting for 18 months, coupled with a 19-month sequential decline in the Leading Indicator Index, has an infallible record in predicting a US recession. In a soft-landing scenario, the US Fed will need to make approximately a 300 basis points cut just to reach a neutral rate setting. However, in the event of a full-blown recession, we are anticipating a need for around 500 basis points of easing.

The December US Fed meeting validated the end of the hiking cycle in short term rates with US Fed Chairman, Powell commenting that “you want to cut rates well before inflation is at 2%” otherwise it would be too restrictive. The US Fed also downgraded its inflation forecast and alluded to three cuts in 2024 as Powell showed concern over keeping rates too high for too long.

The inflation trajectory continues a downward path and heading into 2024 this is expected to persist – we still have some hefty inflation prints dropping out of the index so we should get inflation falling on a year-on-year basis for the first five months of the year if we continue to print similar numbers that have been recorded lately. Continued weakness in energy prices and lower wage growth through a deteriorating employment market would also be supportive of the slowing inflation period. The picture in Australia is also encouraging with the inflation story lagging the global softening prices thematic.  Given the transmission mechanism of Australian interest rates, we would anticipate this to play catch up in the first quarter of next year.

As the new year commences, 2024 is ripe for geopolitical developments with 40 national elections on the calendar from Taiwan at the start of the year through to the US presidential election in November. The potential for a changing of the guard in foreign policy heightens the chances of an escalation or aggravation amongst countries and should fly in the face of the complacency that currently prevails in risk markets and encourage a flight-to-quality demand for sovereign bonds.

After an extended period of ultra-low bond yields, followed by some painful years of adjustment higher, bonds are arguably in better shape now than they have been in several years, offering a sense of stability and optimism for investors in the current financial landscape.