Insight Investment

In the past, monetary policy dominated currency markets. Today, we are seeing a broader set of return drivers. We are observing that countries with stronger growth, healthier fiscal positions and more supportive terms of trade are typically performing well, which can potentially create attractive opportunities. In our view, foreign exchange remains one of the few markets where valuation, macroeconomic fundamentals and policy divergence can all combine to generate differentiated sources of return.

Credit spreads may be tight, but higher underlying yields continue to provide a powerful cushion against market volatility. Over the past 18 months, investors who positioned defensively have repeatedly been challenged by resilient growth, healthy corporate fundamentals and the strength of carry. In our view, the income available today remains attractive enough to justify staying invested despite richer valuations.

US government debt levels remain elevated and there is little evidence that policymakers are willing or able to materially address that issue over the next several years. In that environment, a higher inflation risk premium appears more likely than a lower one. This is one reason why we continue to believe inflation-linked assets are fundamentally cheap in the US and several other markets. While inflation has recently eased in many regions, the underlying fiscal backdrop argues, in our view, for a higher inflation premium over time.

One of the most striking features of the current environment is the strength of the corporate sector. Businesses continue to invest, profits are growing at a robust pace and earnings have surprised to the upside across multiple regions. In our view, corporate resilience is one of the strongest arguments against recession fears.

While political uncertainty is likely to keep volatility elevated, recent market weakness, in our view, has created a potentially more attractive entry point into Brazilian local bonds. We view signs of economic deceleration and moderating inflation as providing a potentially supportive backdrop for rates, and, in our view, Brazil now offers one of the potentially more attractive risk-reward opportunities across emerging market local debt.

Despite concerns around inflation and geopolitics, the global economy continues to show impressive resilience. Corporate earnings have been exceptionally strong with double digit earnings growth in the US and Europe. Critically this is being driven by revenues, suggesting that the economy continues to expand at a healthy pace. While risks remain, particularly around energy prices and geopolitical tensions, we believe the underlying growth backdrop remains supportive for risk assets for now. As far as fixed income is concerned, we believe this is likely to keep investors allocating towards credit markets, despite expensive valuations and increased supply.

After a prolonged period of rising yields, we believe government bonds offer value, and our expectation is that yields should be lower over the next 12 months. In the US, we think the opportunity appears most attractive in shorter maturities, while in markets such as the UK and Japan there is potentially greater value further out along the curve. At the very long-end we remain more cautious, although we have tactically reduced our underweight following the announcement of Treasury buybacks.

Policymakers are increasingly confronting structural and supply-driven problems that monetary policy was never designed to solve. Issues such as fractured supply chains, energy disruptions and housing affordability require longer-term solutions, which is why we believe further rate hikes would offer limited benefits while potentially creating additional economic headwinds. In our view, the Federal Reserve is unlikely to tighten policy further and investors should be cautious about assuming traditional policy responses will work in today's environment.