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Article Type
Market Updates
Topic
Macro
Published
August 06, 2024
Read time
5 mins
Author
Aegon Asset Management
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Market recap: Macro and RatesMarket volatility returned to markets in early August, as various US economic data releases pointed to a continued slowdown in the labor market, with jobless claims higher than expected and payrolls lower than anticipated.The continued slowing in the labor market prompted a significant change in the markets expectations for the first interest rate cut from the Federal Reserve (Fed), with the speculation about a potential inter-meeting cut.Against this backdrop, volatility spiked with risk assets coming under pressure and the rates market experiencing a meaningful repricing in the first few days of August.Spreads widened within fixed income. However, the move was relatively orderly compared to prior significant sell-offs. The spread moves are arguably overdue, with valuations now closer to fair value given how tight spreads have been across most fixed income segments.While the repricing is presenting more attractive valuations and pockets of opportunity exist, we do not believe that now is the time to materially add more risk given the potential for additional volatility and uncertainty.Despite a bounce back during the past day or so, we believe that weakness could persist as the market further digests economic data and geopolitical risks persist in the Middle East.While the market volatility is raising questions about the potential for a recession, this is not our current view. Weve been calling for a slowdown to below-trend growth for some time due to tight monetary policy working its way through - now its materializing. However, for a contraction in the economy to occur, the current trends would need to accelerate to the downside. We currently give that about a 30% chance of happening.Currently, the data is consistent with modest economic growth in the second half of the year, which we believe is consistent with a Fed starting its next rate-cutting cycle at the September Federal Open Markets Committee meeting. We currently see sequential 25 basis-point (bp) cuts during the next 10 meetings, which would take the fed-funds rate to a much more neutral level of 3.0% by the end of next year.A portion of this market reaction appears to be a levered unwind. Speculative money that was borrowed in yen and invested elsewhere in the world is being repatriated. Such unwinds can cause a spike in short-term volatility, much more than the underlying fundamentals support.EquitiesGlobal equity markets peaked in mid-July and have seen a sharp rotation since then.The market rally from November 2023 to that peak was extremely narrow, with the majority of returns generated by the Magnificent Seven and other stocks with exposure to the theme of artificial intelligence (AI).The fact that only two sectors in the MSCI ACWI index - tech and communication services (i.e. tech in disguise) - outperformed the overall index in the first half of 2024 illustrates this point.It was, therefore, always likely (and it could be argued healthy) that, at some point, there would be a correction led by momentum fading.This was sparked in mid-July by quarterly results from a couple of the Magnificent Seven names that were slightly short of expectations. That caused weakness in those shares, which then rippled out across other areas of tech, notably semiconductors.The action then intensified at the start of August due to a combination of factors. Weak manufacturing data followed by a below-par employment report in the US last week shook the broadly accepted a no-soft-landing narrative, which sparked fears the economy would enter a recession after all.Technical factors also likely had an effect. Crowded positioning in large-cap tech and Japanese stocks meant that these areas were susceptible to sharp falls as positions were unwound.The Bank of Japans decision to raise interest rates caused some unwinding of crowded carry trades, where investors had borrowed in yen due to the low interest rates in Japan and invested in higher rate assets. As the yen strengthened on the back of the rate rise, it prompted many investors to get out of that trade and also hit export-focused companies in Japan that had been benefitting from the weak currency. This caused a -12% fall in the Nikkei 225 index on Monday, August 5, which marked their worst one-day sell-off since Black Monday in 1987. The index did, however, regain its poise with an equally impressive 10% gain the following day.Much of recent volatility has been exacerbated by fear and systematic trading. Not much changed fundamentally for the S and P 500 over the previous weekend but the CBOE Volatility index suddenly shot up above 60 for a brief period on Monday, before falling back.All in all, we believe this looks like a correction in a relatively expensive market that has been on a good run and where positioning had become crowded in a few winning trades.Across equity portfolios, we have sought to reduce risk, particularly tech names with AI exposure and expensive industrials in order to lower portfolio betas and see them more defensively positioned, which should stand them in good stead if the current selloff intensifies.High yield bondsHigh yield was not immune from the market volatility and spread widening on August 5, however the moves were relatively muted and orderly compared to some other risk assets (notably equities). The OAS on the ICE BofA US HY index moved wider from around 325 bps as of July 31 to 393 bps as of August 5. The European HY index OAS also moved wider by around 50 bps over the same period. As you would expect, the spread moves were more pronounced in US HY given the impact on the local economy.However, this weakness was short-lived as investors stepped in to buy the dip on August 6, resulting in spreads tightening as the market retraced some lost ground. US HY OAS tightened to 367 bps as of August 6, 2024.In general, a widening in spreads to more attractive levels has been long overdue from our perspective and is a welcome development for valuations. Spreads are now arguably closer to fair value after hovering around historical tights for some time.During the sell-off earlier in the week, the spread widening was mainly concentrated in higher beta, lower rated and/or cyclical risk has suffered more than higher-quality or better-rated high yield bonds.While the sell-off was relatively orderly across sectors, weakness has been evident in areas such as automotive and while earnings have been mixed across the board, there is growing evidence pointing to a consumer slowdown.With respect to positioning, we remain relatively defensive, with a focus on income generation and downside protection rather than upside capture.The recent repricing in high yield bonds has left the high yield market with more palatable spread levels coupled with the elevated all-in yields. While spreads are not signaling a significant buying opportunity yet, and spreads could widen further if economic data deteriorates more rapidly than expected. In addition, a Fed rate cutting cycle could help offset some of the potential spread widening. The current dynamic of modestly wider spreads and elevated all-in yields could present interesting entry points ahead for the more tactical buyers.Investment grade bondsUS jobs data pushed yields lower on Thursday and Friday (August 1 and 2).While generic levels are certainly more attractive, as of this writing, than they were 10 days ago, the increase in rate market volatility (which we think can sustain) does not yet make it an appealing enough prospect to justify a wholesale increase of investment grade risk.Dollar investment grade spreads have widened at an index level by roughly 30 bps during the past week, with euro investment grade around 20 bps wider and Great Britain pound approximately 10 bps wider.The dollar market is now trading at year-to-date wides.The bias of the rates team currently is to continue to lean against the new aggressive market pricing (given a further five or six rate cuts from the Federal Reserve are now priced into the US yield curve).We will continue to monitor both Federal Reserve speakers and US market data (especially employment data).

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Aegon Asset Management

We are active global investors. In a complex world we think and act across traditional boundaries. We organize our teams globally by asset class, to bring the breadth and depth of our investment and research capabilities together for clients across the world. 

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