CIO Views: Interest rate cut hopes drive bond returns
- 30 September 2024 (3 min read)
Fixed income benefiting from lower rate expectations
Lower interest rate expectations – further confirmed by the Federal Reserve’s September cut - have helped drive recent strong fixed income performance. Global government and corporate bond returns over the third quarter have been among the strongest of the last 10 years. Bond yields may not be able to fall much further given what is already priced in. For rate expectations to decline further, markets would need to think that recession risks are increasing, which is not currently the case.
We prefer bonds with shorter maturities, which should benefit from lower central bank interest rates, and corporate bonds which are attractive at current yields. Fundamentals in the corporate sector are solid and demand for higher yielding, income-generating assets remains strong.
European earnings improve, but still lag the US
Following five quarters of negative earnings growth, European equities are back in positive territory. However, absolute earnings growth still lags Wall Street by a considerable margin. This could be for two reasons: firstly, structural factors including relatively low productivity, regional fragmentation and implementation issues on European Union projects – such as the Banking Union - continue to depress Europe’s potential growth rate.
Secondly there are sectoral differences. Some 20 years ago, the information technology sector represented 16% of the S&P 500’s and 4% of the Stoxx 600’s market capitalisation. By the end of 2023, that had increased to 29% in the US, but only 7% in Europe. Industrials and healthcare have gained in importance in the bloc since 2004 – but the tech imbalance could be a key factor in Europe’s long-term outlook.
Asia-Pacific trade powered by AI
US investment in technology is supporting Asia’s tech trade - despite worries about artificial intelligence (AI) overhype. US capital goods imports remained robust over the past year, driven by industrial machines, computers, computer accessories and semiconductors - likely due to AI-related investment and the 2022 CHIPS act.
The initial winners of the investment cycle have been infrastructure firms, storage providers and chipmakers – many of them based in Asia ex-Japan. Taiwan recorded sharp growth in chip exports of 89.8% year on year to September 2024, while South Korea’s rose by 44%. The drivers are undoubtedly narrow and could be derailed if demand falters, but for now, with under-investing in AI perceived as a bigger risk than over-investing, the cycle likely has further to run.
Asset Class Summary Views
Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.
| Positive | Neutral | Negative |
|---|
CIO team opinions draw on AXA IM Macro Research and AXA IM investment team views and are not intended as asset allocation advice.
Rates | Easing cycle in full swing but much is already priced in | |
|---|---|---|
US Treasuries | Market already priced for significant rate cuts in 2025 | |
Euro – Core Govt. | Little value right now with ECB rate cuts priced in | |
Euro – Peripherals | Presents opportunities and higher real yields than Bunds | |
UK Gilts | Interest rate cuts fully discounted; markets await fiscal plans | |
JGBs | Uncertainty over Bank of Japan policy normalisation path. Yen remains volatile | |
Inflation | Market pricing not discounting any post-election inflation shock |
Credit | Favourable pricing is increasing the asset class’s contribution to excess returns | |
|---|---|---|
USD Investment Grade | Without significant growth deterioration, credit to remain resilient | |
Euro Investment Grade | Resilient growth and lower interest rates support credit’s income appeal | |
GBP Investment Grade | Returns supported by better growth and expectations of rate cuts | |
USD High Yield | Narrative of growth without inflation is supportive. Fundamentals and funding remain strong | |
Euro High Yield | Strong fundamentals, technical factors and ECB cuts support total returns | |
EM Hard Currency | Higher quality universe, well-placed with US interest rate cuts commencing |
Equities | Soft landing to support stocks into year-end | |
|---|---|---|
US | Lower rates should sustain confidence in earnings | |
Europe | Attractive valuations, along with positive economic and earnings surprises | |
UK | Relatively more attractive valuations and positive economic momentum | |
Japan | Benefitting from semiconductor growth. Reforms and monetary policy in focus for broader performance | |
China | Policy announcements may lead to improved growth and market performance | |
Investment Themes* | Secular spending on technology and automation to support relative outperformance |
*AXA Investment Managers has identified six themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Technology & Automation, Connected Consumer, Ageing & Lifestyle, Social Prosperity, Energy Transition, Biodiversity.
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