Our House Views

1. What is the shape of the yield curve telling us?

• We believe the Fed is done with rate hikes because inflation has fallen significantly (3.7% y-o-y for September) and the tightened financial conditions driven by volatility in the markets have done some of the work for the Fed. The Middle East crisis also adds to the downside risks to US and global growth. We expect to see the first rate cut in Q3 2024.   
• While the Fed outlook mainly affects short-dated bond yields, the stronger-than-expected US economic data and concerns about high bond supply due to excessive US budget deficits and the resulting funding needs have pushed up bond yields for longer maturities. The term premium (compensation for economic and policy uncertainty above the markets’ best assessment of the long-term policy rate path) has increased, leading to a less inverted Treasury yield curve and a steeper slope for investment grade. Investors who hesitated to lock in yields for too long previously should now be more convinced to do so.
• The current high real yields are unsustainable in our view but provide a good entry point to investors. We prefer high quality bonds and take advantage of the surge in yields to increase our duration positioning across DM government bonds to “medium-to-long” (7-10 years), favouring US Treasuries and UK gilts. We maintain overweight on investment grade bonds for medium durations (5-7 years).
  

2. What should investors expect from the US earnings season?

• We think Q3 earnings in the US should surprise to the upside thanks to strong economic growth, continued disinflation and margin expansion. US banks have largely been beating expectations due to stronger-than-expected net interest income, loan growth, sales and trading activity and investment banking fees. The higher-for-longer policy rate environment is also positive for banks.
• Having said that, we are balanced between value and growth stocks to manage rate volatility. We upgrade Global and US energy to overweight because rising geopolitical risks and low US crude oil inventory levels should keep energy prices elevated in the short term.
• When the market fully prices in the soft-landing scenario and the prospects for lower market and policy rates next year, we expect US equities to outperform and they remain our biggest equity overweight due to US economic resilience. Sector-wise, our preference for technology, industrials, consumer discretionary, financials, energy and healthcare is well supported by fundamentals.

3. How should investors manage heightened geopolitical risks?

• The outbreak of the Middle East crisis has shocked the world and the event continues to evolve. Initially, there was a flight to safe havens such as the USD, US Treasuries and gold but we’re seeing two-way volatility.
• During the Yom Kippur war of 1973, the OPEC oil embargo caused crude oil prices to rise from USD4/bbl to USD15/bbl before falling back to USD11/bbl, leading to a sharp fall in business confidence and economic activity. As calculated by the IMF, a 10% rise in crude oil prices typically leads to a 0.4% increase in inflation and a -0.15% reduction of growth forecasts. However, as the US is now less dependent on foreign oil, the market impact should be less than in 1973 unless the situation escalates.
• Nevertheless, volatility is likely to remain high and it’s important to stay diversified and focus on quality. Our preferences include US Treasuries, UK gilts, Indian sovereigns and investment grade for bonds, and US and Asia ex Japan (India and Indonesia) for equities, with a focus on companies with strong market positions and balance sheets. We overweight the energy sector across regions on higher oil prices.