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FICC Recap: November 2023

Updated: Dec 30, 2023


Co-Head: Daniel Dutch

Analysts: Alessio Di Bon, Harry Young, Mustafaa Ahmed, Laszlo Batthyany


FIXED INCOME:


Key Fixed Income Market Drivers:


Recent announcement of below forecast US job data indicates end to FED hiking cycle


Similar to US, BoE is likely to have finished raising rates too, with 5.25% the terminal level. 


Japanese YCC looks set to be abandoned slowly and gradually over the coming year. 


Italy’s fiscal deficit set to be 0.8% higher than initial targets and 2.3% above EU’s cap of 3% of GDP.


Chinas poor performing property market causes stagnant economic growth and falling yield curve.


USA Overview:


Interest Rate = 3.7%

Inflation = 3.7%


Oil Prices surged nearly 3% in early October as the price of the Brent crude climbed to $97.06 per barrel, reaching a 10-month high, before falling to $92.20 by the end of the week. Oil prices have risen by 30% since June after Saudi Arabia and Russia voluntarily decided to cut oil production until the end of the year (Mosolova, Kerr and Steer, 2023). 

This had major implications on the yields of US Treasuries as investors have deemed that higher oil prices will be passed onto consumers, subsequently trickling down to core inflation (Megaw and Mosolova, 2023). This has ultimately led to the belief that interest rates will stay higher for longer as a hawkish FED aims to reduce inflation. Consequently, the yields on longer term US Treasuries have risen as investors sell these now less attractive issues. The yield on 10-year Treasuries had their largest monthly jump this year as they hit their highest level since 2007, now 4.63% (Kerr and Steer, 2023). In the last month however, yields have tumbled as the market comes to terms with the fact that rate hikes are over. This became apparent as US job data grew below forecast, signalling that the FED would not harm their other objective of strong employment any further.



UK Overview:


Interest Rate = 5.25%

Inflation = 6.7%


UK prices rose by 0.3% less than expected in August as inflation data came in at 6.7%, compared to the 7% anticipated by economists (Giles and McDougall, 2023). As inflation cools, the markets have lowered their expectations of a rate rise from 5.25% to 5.5% and instead it is expected that rate hikes are now done. On this news, 2-year GILT yields fell by 0.14% to 4.85%. An ice Bank of America index of gilts has risen by 2.7% in the last month as the outlook for UK inflation improves. This has led investors to scale back their short positions on GILTS, which have now dropped below $65bn. This was over $110bn at the start of 2022. Lower energy prices will also help in cutting inflation, although prices won’t be near the target 2% level until at least 2025. It is for these reasons that interest rates are likely to have reached a terminal level at 5.25%, with cuts expected to occur around this time next year.



Japan Overview:


Interest Rates: -0.1%

Inflation = 3%      


In Japan, the economic outlook suggests a sustained recovery trajectory with anticipated volatility throughout and beyond Q4 2023. Although core CPI inflation, excluding fresh food, is expected to decrease, it is foreseen to exhibit increased resilience over time, supported by ongoing wage hikes. Notably, the Bank of Japan (BOJ) has undertaken a significant policy shift by redefining the 1% level of the 10-year Japanese Government Bond (JGB) yield from a 'rigid limit' at the upper bound to a more flexible 'reference.' This adjustment reflects a slow approach to unwinding yield curve control, compared to a child picking apart a gingerbread man, as they start with the small features before tackling the main structure of it! There are indications that YCC will be fully phased out by Q2 2024, and that the BOJ may abandon Negative Interest Rate Policy (NIRP) in Q3 2024 or later. These potential changes in monetary policy are contingent on the establishment of a virtuous cycle between wages and prices, reinforcing the dynamic nature of Japan's fixed income landscape (Nomura, 2023).



China Overview:


Interest Rates = 3.45% 

Inflation = -0.5%


November saw interest rates in China remain at 3.45%, having been lowered to this level back in August. This comes as a result of a poor performing property sector, slowing external demand and drags from tapering pent-up demand. One of the biggest hurdles in this recovery comes from the large amount of unfinished presold homes in lower tier cities. Hence, his has caused deflation to occur and the need for lower interest rates in the hope of stimulating economic activity. This has caused a shift downwards in the 10-year Chinese government bond yield curve relative to this time last year.



Italy Overview:


Interest Rates = 4.5%

Inflation = 1.7%  

  

The Italian government has updated its projected fiscal deficit, anticipating it to reach 5.3% of the GDP, up from their initial target of 4.5% (Kazmin and Ricozzi, 2023). This could lead to tensions as it is above the EU’s cap of 3%. Italy does not expect to reach this until 2026. As a result, Italy’s 10-year bond rose by 0.17%, nearing an 11-year high to 4.96%. The spread over the German 10-year bond increased to 1.95%.


Future Global Outlook:


In recent months government bonds have started looking more attractive for several reasons.  Firstly, policy rates have likely peaked with a “soft landing” scenario looking increasingly likely. Furthermore, credit opportunities may seem more fortuitous as the yield curves become steeper. To give an outlook for fixed income, it is important to understand the underlying macroeconomic situation – looking at future growth and inflation rates as well as macroeconomic policy:


Growth 


With regards to growth, the attractive “soft landing” is not a certainty.  

In the US, consumer spending is rising. This positive effect on growth can be explained by low savings rates, a looser fiscal position and inflation falling below wage growth. However, like in many other economies, higher oil prices have started to halt the job growth and disinflation. A soft landing may seem unconfirmed with excess savings being used up and low growth rates in China and Europe.  In China, emerging stimuli may help cyclical momentum and improving growth rates. Yet this will not completely cause a turnaround with property markets holding behind. Europe too has arrived at some standstill. Manufacturing sector inefficiencies were previously offset by the services sector, yet with the latter rising above pre-pandemic trends, investors should be prepared for a stagnation in Europe, and even a recession. Low unemployment rates have been highly valuable in providing some positive outlook for Europe, yet sharp increases in policy rates have been harmful. 


Inflation 


The inflation outlook is promising. Central banks have been trying to curb the high inflation through tightening monetary policy. Central banks must still be cautious however, ready to bring inflation down too much with their monetary policy rather than too little. Core inflation is trending downwards due to a softening CPI. Investors should be aware of the recent surge in oil prices which could diminish recent progress. There will be regional variations – in Japan inflation has arrived and China may see future disinflation with the FX weakness. 


Fiscal Policy 


In the US and Eurozone, we may start to see fiscal policy become less supportive. The US saw in the first half of 2023 that there was lower income tax due to the previous year’s weak performance of financial assets. Furthermore, there has been a recent resumption in federal student loan repayments. Meanwhile in Europe, the energy-crisis support meant that fiscal spending was high. Moving into 2024, Europe’s fiscal stimulus may weaken as the energy-crisis and pandemic support becomes less necessary. Interestingly, China may be more supportive but if debt increases too much it may follow a similar pattern. 


Monetary Policy 


Economies are now moving into the period of reaching their rate peaks or even starting to cut them. With inflation starting to fall, the central banks must slowly start to find their bliss point. In Latin America, central banks are ahead in the cycle and therefore thinking about cutting. In Japan, policy rates continue to remain negative. However, the Bank of Japan is looking to turn this by 2024 in modifying its yield curve policy. Generally, with rising oil prices and still uncertainty, it is likely that central banks will be more restrictive even if inflation were to recede. However, the Bank of Japan is looking to turn this by 2024 in modifying its yield curve policy.  


Investment Implications:


With bonds, yields must rise to attract prospective investors. Consequently, given the yield curve inversion, investors can earn “much more competitive rates owning bonds with relatively short holding periods of three months to two years,” according to Rob Haworth, senior investment strategy director at U.S. Bank. Inflation risk is certainly a concern, reducing future capital values and diminishing purchasing power from future incomes, but these fears are primarily reflected in longer dated bond prices. Thus, short-term money market funds have frequented headlines recently. Interestingly, however, U.S. Bank recommends investing across the maturity spectrum to provide diversification. Indeed, although rate cuts are highly likely, they are no longer perceived as an unequivocal certainty. With that said, once market sentiment finally shifts and starts to price in interest rate cuts, bonds should provide scope for capital growth too.


Specific Fixed Income Investment Opportunities


Colchester Global Bond Fund:

For investors looking to capitalise on these opportunities, a bond fund serves as the most accessible vehicle. The Colchester Global Bond Fund, for instance, is placed in Fidelity’s Select 50 list of preferred funds and is managed by a team of experienced professionals. Predominantly concerned with sovereign bonds, it has low correlations with corporate bonds and equities, acting as both a hedge against a greater than expected economic downturn and a high-quality portfolio diversifier.


Vanguard Total International Bond ETF:

Other funds provide exposure to both UK and global markets, as listed above in the Forbes’ Pick of The Best Bond ETFs from May 2023. With AUM of $50.7bn, the Vanguard Total International Bond ETF, for instance, is an ex-US fund, providing geographic diversification with a weighting of 50% Europe, 22% Asia-Pacific and 7% emerging market. 


iShares iBoxx $ Investment Grade Corporate Bond ETF 

For investors with a higher risk profile, corporate bonds are a traditional route although with government yields nearing recent highs, this is less attractive. The iShares iBoxx $ Investment Grade Corporate Bond ETF owns debt instruments solely from high credit rating companies, such as JPMorgan Chase, with ratings of BBB and above.


CURRENCIES


The global currency market in November 2023 saw notable movements, significantly influenced by central bank policies, economic developments, and geopolitical events. The US dollar experienced a sharp decline, the largest since 2022, due to changing market perceptions of Federal Reserve policy. The Japanese yen showed mixed performance, while the Euro gained strength. The British pound strengthened against the US dollar and the Euro, and the Chinese Renminbi saw a substantial appreciation.


US Dollar (USD)


Market Dynamics: 

The US dollar weakened significantly in November, with the largest drop since 2022, falling by 3.0% as illustrated in the graph below. This was primarily due to market scepticism over the Federal Reserve's "higher for longer" interest rate policy (Morgan Stanley, September 2023), as inflation fell more sharply than expected, leading to lower yields​​, as illustrated in the graph below.



Outlook:


The Fed's early November meeting maintained the fed funds rate between 5.25% and 5.50%, with ongoing balance sheet reduction. However, comments from Fed Governor Waller suggested a potential shift in policy, indicating possible rate cuts in 2024 as inflation showed signs of easing (Jeff Cox, November 2023). This has led to a re-evaluation of the dollar's strength, with some anticipation of a near-term rebound​​.



Japanese Yen (JPY)


Market Dynamics: 

In November, the yen strengthened against the US dollar but weakened against the Euro as illustrated in the graphs below. The Bank of Japan’s Yield Curve Control (YCC) framework and its key policy rate remained unchanged. However, there is growing anticipation of a policy shift, particularly concerning the termination of Negative Interest Rate Policy (NIRP) and YCC in January 2024 (Hermione Taylor, October 2023).



Outlook: 

Despite the yen's strengthening, it underperformed most G10 currencies, influenced mainly by US dollar factors and expectations of more Fed rate cuts (XTB, November 2023). Japan’s aggressive policies to lift inflation closer to the Bank of Japan’s 2% goal and a large stimulus package may limit yen gains for the time being (Kenichi Onozawa​​, November 2023).



Euro (EUR)


Market Dynamics: 

The Euro strengthened sharply against the US dollar, with significant gains in November as illustrated in the following graph. The European Central Bank (ECB) did not meet in November, leaving the key policy rate at 4.00%. However, inflation in the Eurozone is dropping sharply, coming closer to the ECB's 2.0% target​​ (Trading Economics, November 2023).



Outlook:

The Euro's gains are attributed to lower US yields and the slowdown in inflation. Given the weaker-than-expected inflation data in the Eurozone, there is a potential for an earlier than expected rate cut by the ECB, possibly by April 2024​​ (Aline Oyamada – James Hirai, November 2023).


British Pound (GBP)


Market Dynamics: 

The British pound strengthened significantly against the US dollar and modestly against the Euro as illustrated in the graphs below. The Bank of England held its key policy rate at 5.25%, indicating persistent inflation risks in the UK, which appear higher than in the Eurozone or the US​​ (Bank of England, November 2023).



Outlook: 

The UK’s inflation scenario remains more problematic, with core and services CPI rates still elevated (Office for National Statistics, October 2023). This could lead the Bank of England to be more cautious in cutting rates compared to the ECB and the Fed, potentially resulting in some modest outperformance of the GBP initially​​.



Chinese Renminbi (CNY)


Market Dynamics: The Renminbi appreciated significantly against the US dollar in November as illustrated in the following graph. The People's Bank of China kept its medium-term lending facility and loan prime rates stable, reflecting a cautious monetary policy approach (Bloomberg News, November 2023).


Outlook: Despite a slowdown in China's growth indicators (Statista, August 2023), positive policy initiatives are expected to support the property sector and the broader economy. This, along with a favourable restocking process and expected improvement in consumption and investment, could strengthen the Renminbi in the year ahead.



COMMODITIES


Energy prices:


Experiencing a decline of approximately 29 percent in the year 2023, energy prices are anticipated to decrease by 5 percent in 2024, influenced by a subdued global growth environment that has alleviated demand pressures. Subsequently, projections indicate a further reduction of 0.7 percent in 2025.


The Brent crude oil price forecast for the current year anticipates an average of $84 per barrel in 2023, implying an almost $90 per barrel average in the last quarter. Persistent concerns surrounding the conflict in the Middle East, geopolitical risks, the contraction of OPEC+ supply, and pressures from middle-distillate demand are expected to lend support to prices in the concluding quarter. Nonetheless, these comprehensive projections underscore the expectation of a limited impact from the conflict, assuming it does not escalate into a broader confrontation. Furthermore, the forecast operates on the assumption that global oil production `will increase both within and outside OPEC+, contingent upon the reversal of certain OPEC+ supply cuts in early 2024.


Following a record plummet in European natural gas prices earlier in 2023, projections indicate a 4 percent decline in natural gas prices for 2024, attributed to decelerated demand. The forecast is contingent upon relatively mild weather conditions in the Northern Hemisphere and an absence of supply disruptions. Concurrently, coal prices are anticipated to sustain a downward trajectory due to heightened supply and diminishing demand, driven by the continued displacement of coal consumption in power generation and industrial applications.


Gold:


Investors choose gold for its low short-term fluctuations in prices; however, currently, this may not hold. Typically, when markets are struggling, demand and consequently prices tend to rise, given that it is seen as an asset able to retain its value for longer-term outlooks. The addition of gold to a portfolio can be useful for diversification of risk and a wider breadth of returns. With the cost of living and inflation soaring last year, gold could have been a good bet – and it was, given it rose 9.46% YTD. However, with inflation rates falling and consumer confidence repairing, gold is now falling after hitting an all-time high on 1st December.


Is it a good investment then? It depends. Given that gold is typically used to hedge against inflation, timing is key. Reports from The World’s Gold Council suggest that there is only a 5%-10% chance that economic scenarios – including a soft landing or recession – would put downward pressure on prices and instead push prices "notably higher." While this may be linked to the improving, but still troubling, times, investors must consider important landmarks in history (such as tensions regarding the US election and further interest rate cuts). It is this uncertainty that underpins gold’s potential growth in 2024.


Not all is so simple, however. It is important to note that each gold cycle is different, following years characterized by uncertainty with inflation, interest rates, and geopolitical tensions. Gold this year benefited greatly from central bank purchases, increasing by more than double despite the year not being over. These demonstrate the irregular setting we find ourselves in. It is important for investors to take precautions and consider macroeconomic factors when deciding on gold’s future.


Agricultural prices:


These are forecasted to fall by 7 percent in 2023 and a further 2 percent in 2024 and 2025, owing to ample supplies. Food and beverage prices will decline slightly more, while agricultural raw materials will rise by over 1 percent. Following a more than 11 percent fall in 2023, the grains price index is projected to fall by 4 percent on average in 2024 and 2025 amid ample supplies and adequate stock levels. However, rice prices will remain high into 2024, assuming India maintains its export restrictions. The outlook assumes a moderate-to-strong El Niño. Sugar and cocoa prices are expected to decline from 2023 highs, though fruit prices should remain high in 2024 due to weather-affected supply shortfalls. Fertilizer prices are expected to decrease as more supplies come online, but they are likely to stay above historical averages due to some supply constraints and China’s ongoing fertilizer export restrictions.


Base metals:


Prices are projected to fall 5 percent in 2024 due to slowing demand and rebound in 2025 on recovering global industrial activity. Even though activity in China’s property and construction sectors is anticipated to stabilize by 2024, these sectors will increasingly have less influence on global metals demand than they did in the previous two decades. 



References 


  1. Aline Oyamada – James Hirai, Bloomberg (November 2023). “Traders Bet on Earlier and Deeper ECB Cuts as Inflation Slows”. https://www.bloomberg.com/news/articles/2023-11-30/traders-fully-price-ecb-rate-cut-in-april-for-first-time?leadSource=uverify%20wall

  2. Bank of England (November 2023). “Bank rate maintained at 5.25% - November 2023”. https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/november-2023

  3. Bloomberg News (November 2023). “China Pauses Rate Cuts as Focus Shifts to Credit Stability”. https://www.bloomberg.com/news/articles/2023-11-20/chinese-banks-maintain-lending-rates-after-pboc-policy-rate-hold?leadSource=uverify%20wall

  4. Giles, C. and McDougall, M. (2023). Investors slash bets on UK rate rise after inflation falls to 6.7%. Financial Times. [online] 20 Sep. Available at: https://www.ft.com/content/687fca49-efb5-4203-8c27-605d473cbfb6 [Accessed 2 Nov. 2023].

  5. Hermione Taylor, Investors’ Chronicle (October 2023). “What the Bank of Japan is trying to do”. https://www.investorschronicle.co.uk/news/2023/10/17/what-the-bank-of-japan-is-trying-to-do/

  6. Jeff Cox, CNBC (November 2023). “Fed’s Waller expresses confidence that policy is in the right place to bring down inflation”. https://www.cnbc.com/2023/11/28/feds-waller-expresses-confidence-that-policy-is-in-the-right-place-to-bring-down-inflation.html#

  7. Kazmin, A. and Ricozzi, G. (2023). Italy raises budget deficit forecast amid mounting economic pressures. Financial Times. [online] 28 Sep. Available at: https://www.ft.com/content/e2c0cf09-ad93-4aba-954d-e6e4971a59f1 [Accessed 2 Nov. 2023].

  8. Kenichi Onozawa, Nikkei Asia (November 2023). “After BOJ policy tweak, focus turns to exit from negative rates”. https://asia.nikkei.com/Economy/Bank-of-Japan/After-BOJ-policy-tweak-focus-turns-to-exit-from-negative-rates

  9. Kerr, J. and Steer, G. (2023). US stocks notch quarterly drop against backdrop of Treasury sell-off. Financial Times. [online] 29 Sep. Available at: https://www.ft.com/content/754a8093-a4f2-4f1b-b786-998cb2ea2c7a [Accessed Nov. 2023].

  10. MarketWatch. (2023). China 10 Year Government Bond. [online] Available at: https://www.marketwatch.com/investing/bond/ambmkrm-10y?countrycode=bx [Accessed 21 Nov. 2023].

  11. McDougall, M. (2023). Hedge funds rush to unwind bets against gilts. Financial Times. [online] 24 Sep. Available at: https://www.ft.com/content/e97731b2-8c52-4088-bdd1-21e39d60697a [Accessed 2 Oct. 2023].

  12. Megaw, N. and Mosolova, D. (2023). US stocks rally as oil price retreats from recent high. Financial Times. [online] 28 Sep. Available at: https://www.ft.com/content/ef361aa4-cb62-4512-85ae-9eceff9fe894 [Accessed 2 Nov 2023].

  13. Mosolova, D., Kerr, J. and Steer, G. (2023). Crude climbs above $96 a barrel on US stockpiles concern. Financial Times. [online] 27 Sep. Available at: https://www.ft.com/content/a789507e-c540-4082-a8f0-c172325aa251 [Accessed 2 Nov. 2023].

  14. Nomura Connects. (2023). What’s on the horizon for the global economy? [online] Available at: https://www.nomuraconnects.com/focused-thinking-posts/the-economy-next-week/ [Accessed 21 Nov. 2023].

  15. Statistica (August 2023). “Key economic indicators of China - statistics & facts”. https://www.statista.com/topics/5819/key-economic-indicators-of-china/#topicOverview

  16. Tradingeconomics.com. (2023). Japan Interest Rate. [online] Available at: https://tradingeconomics.com/japan/interest-rate [Accessed 21 Dec. 2023].

  17. XTB (November 2023). “Chart of the day - USDJPY (20.11.2023)”. https://www.xtb.com/en/market-analysis/chart-of-the-day-usdjpy-20-11-2023



The opinions expressed in the reports are those of the members of the Junior IB team and are not affiliated with any university or institution. The financial recommendations provided are for educational purposes only and the Junior IB team takes no responsibility for any losses that may occur from implementing any ideas presented in the reports. The Junior IB team is not authorized to provide investment advice. The information, opinions, and estimates presented in the reports reflect the Junior IB team's judgment at the time of publication and are subject to change without notice. The price, value, and income of any securities or financial instruments mentioned in the reports may fluctuate. The Junior IB team has no business relationship with any of the companies mentioned in the reports and does not receive any compensation for their inclusion.


Copyright © December 2023 | The Junior IB.

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