In the first quarter, the steep rise in interest rates over the past 12 months collided with record high debt levels, leading to the largest banking failures since 2008. Nonetheless, the bullish yield curve steepening in March has recently given way to a strong risk-on regime, with equities and credit spreads rallying and yield curves bear flattening. Market action clearly seems to imply that the cat is back in the bag. But will this persist?
We retain the view that the risk of recession has not disappeared, and that labor market weakness could be the catalyst for a change in market sentiment. For now, central banks seem to need a tie break to win their war against inflation and are extending their tightening cycles, even as headline inflation recedes and growth weakens. This reinforces our view that lower yields, steeper curve and credit opportunities will arrive in the second half.
Get the latest insights
Subscribe to our newsletter for investment updates and expert analysis.
A risk of over-tightening
We see the renewed hawkishness of the US Federal Reserve (Fed) but also at the European Central Bank (ECB) as a tendency to insure against the possibility of inflation staying more persistent than expected. By targeting real-time core inflation trends, they seem to be accepting the risk of over-tightening.
Markets have moved in line with this narrative. The pricing of the December 2023 Fed Fund contract says it all. In March, in the wake of the failure of Silicon Valley Bank, the contract rallied an astonishing 170 basis points (bps), completely pricing out hikes and actually pricing in Fed cuts by year-end. Since the low in mid-March, this move was nearly completely reversed after a 140 bps sell-off. Fed year-end pricing is back to levels where things started to crack for small and medium-sized US banks.
Read the full Fixed Income Q3 Quarterly Outlook here
Important information
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong. This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions. The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.