Hani Redha:

Welcome to the PineBridge Investments Podcast. I’m Hani Redha, Head of Strategy and Research, Global Multi-Asset. With me is Anders Faergemann, Head of Global Sovereigns and Economics, and we’ll be discussing the global rates and FX update. We have just concluded our strategy meetings for the month. So, Anders, how would you summarize the conclusions we reached?

Anders Faergemann:

Thanks, Hani. Yeah, the overriding conclusion from our investment meeting has been one of lower yields over a 12-month period. That’s really predicated on the view that eventually the US economy will end up in some type of soft-landing scenario. However, that road or pathway to lower yields will undoubtedly be paved with a few downs. Currently, we are experiencing very robust economic conditions carrying over from 2024, and on top of that, we have a lack of clarity over the magnitude and sequencing of Trump’s policies. So in the short term that could lead to an overshooting in yields, and as a result, we agreed to be more nimble and effectively shortening our investment horizon. So, Hani, how does that jibe with your view on the current market themes?

Redha:

Yeah, I’d say that in the discussions, I thought your way of teasing out from our colleagues the issues that we face, both on a three-month horizon versus our usual 12-month horizon, was quite effective. And we can frame that in terms of our global macro scenarios and how the probabilities are shifting between them over these two timeframes. But Anders, I think it would be better if we start out with you summarizing the actual framework itself first; then we can highlight where we are across the scenarios.

Faergemann:

So, Hani, as you know, our process is really driven by the use of scenario analysis. That’s how we track our macro thinking. And each year, we build a base case where we consider the direction of travel for economic growth and inflation as well as monetary policy and fiscal policy. With that, we review the central bank reaction functions over a 12-month horizon. In addition to our base case, we create four alternative scenarios: a bull case, a bear case, and two tail risks. And while we keep the scenarios the same over a 12-month period, what makes the process dynamic is how we change the weight between the scenarios with new information transpiring, or our fundamental views changing. Or indeed, what we saw last year was a shift in market expectations, unsupported by fundamentals, generating trading opportunities.

But overall, this framework helps distinguish the signal from the noise. I think, as I said, 2024 was a good example of that. We kept our stabilization scenario intact whilst the market fluctuated between expecting a US recession to then finally ending up with US exceptionalism carrying over into 2025. And maybe to recap 2024, as a main takeaway, with elevated rates of volatility we saw extreme market swings, mainly in the US Treasury market; as we’ve discussed many times, the narrative flipped many times, not least with the data provisions that you highlighted.

So, since September, we have seen the Fed cutting interest rates by 100 basis points. But at the same time, US 10-year Treasury yields have risen by 100 basis points, and that’s the backdrop we’re up against in terms of explaining the baseline for the 2025 outlook.

So, maybe just to summarize that, the way we think about the US economy over the 12-month horizon is that eventually it should move back below trend growth, and in tandem with that, we expect inflation to move towards the Fed’s 2% target – and with the higher real yields, that would allow the Fed to cut interest rates three times towards the end of 2025 and a policy rate of three and three-quarters percent. So, we refer to this as our “soft landing” scenario, but it clearly is a waiting game. If this view materializes, though, then US rates should be lower. But Hani, how do you see those risks in terms of our baseline?

Redha:

Yeah, the main risk in a year like this is that you could be right about lower yields over 12 months, but really get hurt over the more near term, over three to six months. And that’s why it’s been awhile since we needed to introduce a three-month outlook. The most recent episodes where we needed to do that were in 2020 around Covid and in 2022 after Russia’s invasion of Ukraine.

And so it’s part of the process, obviously, but it’s a rare setup where we need to do that. And right now, we’re in a very volatile period for policy. But that volatility, it’s uncertainty by design – which is what leads us to differentiate between the three-month versus 12-month view, also by design. And the near-term risks are very much skewed for higher yields.

We see the policy mix from the US – mainly around tariffs, but also immigration and fiscal – being things that can lead to inflationary outcomes and higher yields. We’ve also got the Q1 residual seasonality that you and I have discussed extensively, the robust data that you refer to, which we think is a result of the lagged effects of the 100 basis points or so fall in yields into the lows of September last year – and that lifts growth, through the wealth effect, with about a three- to six-month lag, which is where we are now.

So, it’s not surprising to us to see robust data. And the Fed can be cautious in the face of all of that and err on the side of “just wait and see.” But overall, I’d say, if we then stretch to the 12-month view, every month that goes by, higher yields and tighter financial conditions will weigh on growth. So, you’ll see the reverse of the financial conditions effect that we’ve seen that has lifted growth: real yields near two and a half percent are going to have an anchoring effect on growth and inflation.

And we see inflation dynamics around things like shelter also grinding lower, which is why, overall, we still say that remaining in a kind of soft landing is our base case scenario, with 10-year yields falling towards four and a quarter percent. That still makes sense to us on the base case, but we are very mindful of the potential for higher yields over the next few months or so.

So, with those different dynamics and different time horizons, how would you conclude about positioning and the strategy for this year?

Faergemann:

In terms of splitting the rates outcome and the market implications from this discussion, I think it’s important to highlight the higher-for-longer scenario that you described for the three-month; in that context we expect the 10-year Treasury yields to stay around four-and-a-half to five percent.

We’re just trading at the lower end of that range today, but that gives some opportunity to use that range to trade in. A higher-for-longer scenario is also supportive for the US dollar. So, in our forecast, we have a euro/USD forecast of parity if we stay in this higher-for-longer scenario. We’re currently at 105, at the high end of that range. So, again, you can be nimble and opportunistic, but we are aware that the market came in with the view that the USD should strengthen, and so valuations and positions have negated some of that USD strength in recent weeks.

But if we look ahead, Hani, I guess what you’re saying is that it is about the soft-landing scenario. It is about the US economy or the Fed, sort of achieving a soft landing. And with that US 10-year Treasury yields should be lower. We have a forecast of four and a quarter; that translates into a slightly weaker USD, so a forecast of 105 in euro/USD, which is where we are for the moment. So, if we’re actively trading, we’re neutralizing the USD here. But looking forward from a trading perspective, you would want to think about playing for lower yields and adding duration, and that carries some weight into to the second quarter, I believe.

Hani Redha:

Very good. Thank you, Anders – very clear conclusions and actionable recommendations. And thank you all for listening. We will be back next month, and for more information, please visit PineBridge.com. Till next time, thanks for listening.