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CONTRIBUTORS

Paul Mielczarski

Head of Global Macro Strategy,
Brandywine Global

Preview:

Bond yields rise as inflation falls

One of our key macroeconomic calls for 2023 was that US inflation would fall toward the Federal Reserve’s (Fed’s) 2% target. That seems to be playing out with the core Consumer Price Index (CPI) averaging 0.2% month-on-month for the past three months, the equivalent of a 2.4% annualized rate. We expect this trend to continue in the coming months. This time last year, core inflation was above 6%.

Monetary policy tightening impact muted or delayed?

Brandywine Global’s investment framework is based on the idea that large moves in bond yields and currencies create economic responses that ultimately lead to cyclical mean reversions. So far, the US economy as well as equity, credit, and real estate markets have held up remarkably well in the face of a 250 basis point (bp) increase in US 10-year real yields over the past 18 months.

Estimating the lag between monetary tightening and its impact on growth is difficult in a more “normal” economic environment. It is particularly challenging in the current economic cycle, which has seen a combination of massive monetary and fiscal swings, COVID-related consumption shifts and supply-side disruptions, and a 1970s style commodity price shock. Estimating the impact of each individual shock and the extent to which the shocks amplify or offset one another is particularly challenging.

Strategy implications

There is a compelling case for being long US fixed income. Core inflation looks to be on track to reach the Fed’s 2% target. Labor markets are rebalancing rapidly, which should result in lower wage growth. Global growth is rolling over, led by China and Europe. While US growth has been resilient so far, we expect growth to slow as monetary policy lags kick in. US real yields are high relative to trend GDP growth. Fixed income is attractive relative to equities, with US investment grade bond yields above the US equity forward earnings yield for the first time in 20 years, based on the Bloomberg US Corporate Bond Index versus the S&P 500 Index.

Read the full paper to learn more.

Definitions:

The Bloomberg US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non- US industrial, utility, and financial issuers.

The S&P 500 Index is a broad measure of U.S. domestic large cap stocks. The 500 stocks in this capitalization-weighted index are chosen based on industry representation, liquidity, and stability.

A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

 

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