Vijverberg says corporates are already feeling the effects of a higher interest rate environment and coming under increasing pressure as a result. This, he believes, leaves central banks with a delicate policy balance to deliver.
“Central banks are balanced on a knife’s edge,” says Vijverberg. “Inflation still remains well above trend which would imply higher interest rates are needed.
“Yet recent market turmoil, particularly in the banking sector, suggests that rate-sensitive corporates are already beginning to feel the effects of tighter financial conditions. Must we persist with higher rates? That is the question for both policy makers and investors going forward.
“In the wake of SVB and Credit Suisse, regulators and central banks have been quick to intervene to reassure markets. But given how quickly rates have increased, particularly in Western economies, financial stresses are unlikely the end, and we expect more corporates to face pressure going forward.”
Vijverberg says the financial sector crisis has left central bankers with unenviable choices. But ultimately he says the Fed and ECB will continue to hike rates as persistent inflation presents the bigger risk.
“The ongoing crisis in the financial sector leaves central banks, particularly in the US and Europe, in a precarious position. Turmoil in the financial sector ultimately leads to a slowdown in lending as banks look to shore up their balance sheets. Higher rates in itself will also lead to a slowdown in growth, due to their impact on interest rate sensitive sectors like real estate and construction.”
“Lower growth should reduce inflationary pressures. When inflation has returned to or below central bank targets, it could start cutting interest rates to support the economy. This is what markets are now predicting happens. The Fed futures swap curve shows traders expect 50bps in cuts by the end of the year. However, inflation is still well above normal levels of 2%, and the stickier components, particularly services, are yet to show material signs of deflation.”
“Given central banks’ ultimate goal is to bring inflation down, we expect the ECB and US Federal Reserve will continue to raise rates incrementally despite the pain we have already seen in the banking sector. Corporate earnings are expected to decline, defaults and unemployment will likely rise, and the risk of a hard landing from monetary policy increases. That said, there are also some bright spots. For instance, the energy crisis is abating, as measures to limit the impact negative impact have been successful. Also, in general the economy has been more resilient to the energy shock than previously feared.”
Aegon AM asset allocation for Q2 2023
Vijverberg outlines Aegon AM’s updated asset allocation for Q2 2023, with the firm remaining overweight on fixed income, neutral overall in equities and mixed on currencies.
Cross asset allocation
“We remain overweight fixed income versus equities on a cross-asset basis. We continue to be pessimistic in our outlook for economic growth. Higher rates and above-trend inflation represent a headwind for corporate earnings and margins. Therefore, we keep our underweight equity versus fixed income position. Fixed income markets, meanwhile, particularly in credit, should offer attractive yields relative to equity markets. We also have an allocation to cash given the decent yield / low risk combination it now offers.”
Within fixed income
“We continue to be overweight in spread categories relative to sovereigns. We remain underweight duration, specifically in Japanese and European government debt. Central banks have room to tighten further, and the inflation is yet to trend meaningfully towards 2% which is negative for government bonds. Spread categories including investment grade, high yield and securitized are offering potential yields of more than 4% for investment grade and over 8% in high yield, making this an attractive carry trade.”
Within equities
“We are unchanged in our positioning within equities. In most regional markets, we have a neutral conviction, seeing risks of both the downside and upside being fairly balanced at this point in the cycle. We remain underweight in the US, predominantly due to valuation concerns. Forward price-to-earnings ratios are trading on average levels of around 18-19x earnings, whereas typically as we approach a recessionary-type environment this falls to sub 15x.”
“Given our economic outlook for the US, we expect further earnings downgrades which is why we maintain our underweight. We continue to favour Asian markets where we have seen further growth in economic activity and stability in property markets. A weaker US dollar due to falling rate differentials should also be supportive for regional equity assets.”
Within currencies
“We have upgraded our euro score from neutral to overweight. We continue to see upside risks that the ECB continues to increase interest rates – improving economic outlook, China’s re-opening and tighter regulations for European banks mean the ECB can afford to continue hiking in the face of inflation. This is a positive for euro outlook as interest rate differentials rise.”
|
