Analysis from Emma Moriarty, Investment Manager at CGAM
This time last year some of the major Western economies were facing conflicting monetary and fiscal policy stances as they confronted elevated inflation. Governments and central banks had “one foot on the accelerator, the other on the brake”. While central banks were attempting to contain inflation by increasing interest rates and reducing the size of their balance sheets, governments were stimulating the economy by running persistent budget deficits and hence contributing to inflationary pressures.
This contradiction characterised much of 2022 and 2023. Elevated inflation was largely seen as an issue for central banks to deal with, despite the pressure that deficit spending was beginning to place on inflation. However, bond markets are now increasingly sceptical of the fiscal positions of several of the major advanced economies. One feature that characterised the last quarter was seeing markets devote a similar level of attention to fiscal events as had been devoted to central banking events. The most notable example was the positive market reaction to the US Treasury’s decision to slow the pace of increases in issuance of long-dated Treasuries in favour of shorter bonds in response to concerns about the sustainability of the US debt position.1 In the days following the Treasury’s announcement, the 30-year Treasury yield fell from a high of 5.1% back to 4.8% and by the end of the year stood at 4%.
Looking ahead, should we be greedy or fearful in global bond markets in 2024? There is reason for hope and for caution. We expect to see continued tensions between monetary and fiscal policy stance, with monetary policy pushing down on yields while fiscal policy continues to provide upward pressure.
Don’t fight the Fed
One of the themes of the recent round of monetary policy tightening has been “don’t fight the Fed”. In Q4, the Federal Open Market Committee (FOMC) crossed the central banking Rubicon in explicitly forecasting three cuts to the Federal Funds Rate over the coming year. Fed speakers, most notably Lorie Logan, have suggested that the Fed’s quantitative tightening (QT) may also have to be slowed in response to evidence of low liquidity in financial institutions. Taken together, this suggests a continued loosening of monetary policy stance and a corresponding fall in government bond yields. However, we say this with caution – while markets expect policy rates of 3.7% by end-2024, the FOMC’s median prediction is 90bps higher, at 4.1%.
Challenges remain
Against this, the fiscal backdrop remains challenging. For example, in the US, the fiscal deficit projected for 2024 is 6% and government debt is predicted to grow by an additional percentage point of GDP, to just under 100%. And while 2024 will see several general elections take place, we are yet to see a political constituency emerge in favour of running persistent fiscal surpluses in an environment where bond markets have shown a heightened focus on fiscal stance. Given this, ongoing fiscal deficits are likely to provide continued upward pressure on yields – in the short term through elevated supply of government bonds and over the medium term as an aggregate demand stimulus that puts more pressure on inflation.
But what about Japan?
It would be remiss to discuss global bond markets without mentioning Japan. While Western central banks begin discussing when to make the first cuts to policy rates, the Bank of Japan (BoJ) continues to consider crossing a different Rubicon: managing the exit from its yield curve control policy. In an economy with deeply engrained fears of deflation, the Japanese CPI has – for the better part of two years – been above 2%. The brake on exiting yield curve control has been a deep reluctance to tighten monetary policy too early or too quickly and risk deflation. Speculation that the BoJ might use its December 2023 meeting to tweak its stance of monetary policy did not come to pass – instead, the BoJ stated that it will “patiently continue” with its current policy stance until it sees wages increase sustainably. So, we too will patiently continue to wait for the results – and pass through – of the Japanese shunto wage negotiations in the spring.
Global index-linked government bond portfolios entered 2024 in a position to benefit both from falling global interest rate expectations, and from higher realised inflation accruals should our fears of more persistent inflation come to pass. But given continued policy tensions, we expect a bumpy ride.
1. U.S. Department of the Treasury (November 2023), “Quarterly Refunding Statement of Assistant Secretary for Financial Markets Josh Frost”. See https://home.treasury.gov/news/press-releases/jy1864.
Emma Moriarty is an Investment Manager at CGAM
