New Regime, New Opportunities

  • We see different and abundant opportunities in the new macro regime. We go granular within asset classes, regions, and sectors – and harness mega forces.
  • Short-term bond yields rose last week as markets priced policy rates staying tight after U.S. data confirmed persistent inflation and activity holding up.
  • U.S. jobs data is in focus this week. We think labor shortages have made firms reluctant to let workers go, keeping unemployment low even as growth sputters.

We see major central banks holding policy tight in the new macro regime. That bolsters income’s appeal. We’re also pivoting to new opportunities, evolving our playbook to go granular across asset classes, regions, and sectors: The outlook is brightening for Japanese stocks, and we like emerging market (EM) debt as policy looks poised to loosen. We harness mega forces as well, leaning into the digital disruption of AI and private credit as it plays a bigger role in the future of finance.

Holding tight

Markets have come around to the view that major central banks will not quickly ease policy in a world shaped by supply constraints – notably worker shortages in the U.S. Developed markets (DM) can no longer produce as much without sparking higher inflation. So, central banks are holding tight, the first new investment theme in our 2023 midyear outlook. That's a big change from the low-rate environment norm prior to the pandemic. Take the Federal Reserve. It has kept monetary policy loose since the early 1990s – and was quick to cut rates when recessions hit. See the yellow line and gray shaded areas in the chart. We don't see the Fed coming to the rescue. We see more supply constraints in the future compelling central banks to keep policy rates above neutral rates (red line), the estimated policy rate that neither stimulates nor depresses economic growth. That means the policy is going to stay in the restrictive territory.

Policy rates staying tight bolsters the appeal of income – and the case for short-dated government paper. Three-month U.S. Treasury bill yields hit 22-year highs near 5.60% in June. We stay underweight long-term U.S. government bonds as we expect investors to demand more compensation for holding them given sticky inflation. Yet long-term bonds in the euro area and the UK are better at pricing higher rates, so we’re tactically neutral. We stay strategically overweight inflation-linked bonds on persistent inflation. But tactically, we prefer the U.S. over the euro area given the current market pricing of each.

The macro backdrop is not friendly for broad asset class returns, but opportunities abound depending on how much of the macro is in asset prices. So we're pivoting to new opportunities, our second theme, and getting granular. We’re modestly underweight DM equities in our six- to 12-month tactical view as they still don’t price the damage from rate hikes. But Japan stands out. We upgrade Japan stocks to neutral. Why? Fewer supply constraints, supportive policy, and corporate reforms. We tactically prefer EM equities to DM peers as EM policy looks closer to easing. But on a strategic horizon of five years and beyond, we're overweight DM stocks as we see returns above bonds with growth returning and inflation lingering in the U.S.