Hani Redha:

Welcome to the PineBridge Investments’ podcast. I'm Hani Redha, Head of Strategy and Research for Global Multi-assets. And with me is Anders Faergemann, Head of Global Sovereign and Economics. And we'll be discussing the global rates and FX update. We've just concluded our strategy meetings for the month, and we've made some key changes to our outlook, raising our yield forecast for German bunds. And we've also lowered our probability for the trend scenario, where growth would be robust in the US, and we've increased our probabilities for our base case of a soft landing, as well as our recession scenario. But Anders the big political earthquake happened in Europe. So I suggest, let's start there. Take us through the team's thinking about recent developments and their implications.

Anders Faergemann:

So Hani, as you've said before, Europe will only step into action when there is a crisis, and I think from the embarrassment of being left out of the initial Ukraine negotiations between Trump and Putin, Friedrich Merz, leader of the CSU coalition, which won the most votes in the recent election, had his “whatever it takes moment”.

Obviously it still needs to be ratified in the Bundestag and the Bundesrat. Some of the negotiations are going on today. But in big terms, there are three announcements as part of the plan. So, one was a national fiscal rule reform to exclude defense spending above 1% of GDP from the calculation. The second part was an infrastructure spending, very sizable, and our calculation suggests that over a 10-year time frame that adds 2% of GDP, on an annual basis, to Germany's economy.

And then there's a reform of the debt break that provides some wiggle room for the lenders. Obviously, we need to consider the market implications from this, and if we sort of take a back of an envelope calculation, it suggests that the impact on bund yields from a permanent one percentage point of GDP increase in the deficit is around 40 to 50 basis points. In addition, the lift in German growth levels in 2026 and 2027 could add another 20 to 30 basis points.

And I purposely left out 2025, our suggestion is that the sort of imminent growth impact will be quite measured. The multiplier effect only comes into effect later on, and a lot of the infrastructure spending will take time as well, but the multiplier effect is higher here, and then obviously we have the tariff impact.

And I don't know if you're going to touch on that in a minute, but where we are in terms of our bund yield forecast for the next 12 months, we've lifted our 10-year bund yield forecast from 2 by 75% and to 275 which doesn't sound like much when German bund yields are already trading close to 3%. But maybe we can discuss that as part of the conclusion.

So, with that, let's move to the US. We've been through a growth scare. We're still in that but from the discussion in our investment meetings, those are focused on the Fed's dual mandate as well and the inflation impact from tariffs. So how do you summarize our view and what are the risks here, Hani?

Hani Redha:

Sure, it really does feel a time when the world has been turned upside down, with things looking up for Europe, just when we come to perceive a sharper slowdown in the US than we were having in our central scenarios. And you know, it's been partly driven by a recognition of a string of weak data on the consumer side. You know, we've had weak retail sales and personal consumption numbers. You know, the consumer has actually had good income, but has been choosing to pull back spending, leading to a higher savings rate.

On the corporate side, we've been seeing weaker PMIs, particularly in services and CAPEX intentions, which had spiked, there was a lot of optimism right after the election. That's faded to some extent. And what's driving all this? It's two things. One is what we had pointed to last month, which is the tightening of financial conditions late in Q4 has a lagged effect, which then shows up as weaker growth about three to six months later, and that's where we are now. So those lags are doing what they always do and then dampens growth.

But the bigger factor here is really the policy uncertainty, particularly around tariffs. It's tough enough to deal with tariffs as a supply shock, as a kind of a tax on consumers. But on top of that, it's the flip flopping. It's the on-again off-again, that is causing a lot of loss of confidence and more caution, both in consumers and corporate sense. So that's really why we've lowered our probabilities for our trend scenario, which saw growth remaining as robust as it was last year, and coming towards our central scenario, which was a soft landing, which is an actual slowdown from last year's growth rates.

But if this continues, then we recognize that recession probabilities would also be rising far from our base case, but any stabilization and growth will depend on that policy backdrop in the second half of the year, let's say, and so it's going to be difficult to see anything improving unless we get things settling down a bit on the policy front.

But at the same time Anders, I'd say, we need to also keep the positives in mind as well. Deregulating, and as Treasury Secretary Besant called it, “re-privatizing” the US economy will lead to a resumption of US exceptionalism and productive growth. This is just the detox period, and we'll have to see how long that lasts. But overall, the slowdown takes us away from the high growth environment that we didn't think was going to be the base case, but has become even less probable now.

Now, having looked at both the European side of things, which is unusually positive, I'd say, relative to recent decades, and at the same time having an unusual period of weakness in the US, what are the implications, particularly for currencies here?

Anders Faergemann:

Yeah, so for currencies, we tend to look at the yield differential as well as growth differential, and in some circumstances, we look at the terms of trade, but I think for the purpose of this meeting, let's focus on the yield differential and the growth differential. So if you unpack the yield differential, we have revised higher our 10 year bunds forecast to 2.75, we actually kept our treasury 10 year forecast unchanged at 4.25. So, the yield differential there is 150.

Ironically, we sort of pushed back on the Fed cutting rates this year from three cuts to two cuts, because of the stagflation light, the inflation impact and the asymmetric decision making for the Fed. And so, what we end up with is a two-year, two year that's not too dissimilar to what's being priced in by the market at the minute. And so, with that, while we then look at the growth differential, we are looking at a potential increase in potential growth in Germany. But likewise, as we discussed in the last podcast, we are seeing US exceptionalism, AI and productivity coming through over a longer time frame in the US. And with that, I don't see much room for the euro to appreciate from here.

At the moment, the market is trading just shy of 109 which is at the higher levels of what we've seen in the last 12 months and we were potentially overshooting here. Just to finalize on our forecast, we moved our forecast in Euro/Dollar from 105 to 107.50. So let's call it a range of 105/110. I think the significant part of that is more that we are moving away from our trend scenario, where parity was in play, sort of based on the yield differential and US exceptionalism. We've had to push back on that a bit. There's been a significant shift, but not as much as the market implies. Would you agree with that Hani?

Hani Redha:

Yes, and I think that's very clear, thanks Anders. I should say, this is being recorded on the 13th of March. The situation is highly fluid. A lot of what we've just laid out is contingent on Europe and Germany, in particular coming through with the plans that they've laid out. Those negotiations are starting today, and we think it's highly likely that they'll come through, but just a recognition of how unusually fluid the macro backdrop is in reaching our conclusions.

With that, we will be back next month for more information, please visit pinebridge.com. Until next time, Thanks for listening.

ENDS