In a recent interview on Bloomberg Surveillance, Earl Davis, the Head of Fixed Income and Money Markets at BMO Global Asset Management, shared his insights on the current state and future outlook of the fixed income and money markets. His analysis, based on decades of experience, sheds light on the complexities of today's financial landscape and offers a roadmap for investors navigating these turbulent times.
Market Volatility and Treasury Yield Predictions
Davis points out that the factors driving higher rates, such as supply issues and persistent inflation, remain unresolved. He predicts continued volatility in Treasury yields, with both the lower end (3.50%) and the higher end (5%) being tested in 2024. This volatility underscores the need for investors to be agile and responsive to market changes.
Robust Demand for Cash and Shift to Fixed Income
Davis highlights the unstoppable demand for cash that characterized 2023, a trend he believes will persist into the first quarter of 2024. This robust demand is expected to gradually shift towards fixed income, especially as investors become more comfortable with the positive performance of bonds. This shift signifies a changing investor sentiment, moving from the safety of cash to the potentially higher returns of fixed income securities.
Economic Resilience and Investment Strategy
Looking ahead to 2024, Davis is optimistic about the resilience of the economy. He advocates for a strategic approach to investment, favoring investment-grade credit, triple B ratings, and selective high-yield investments. This strategy reflects a nuanced understanding of the market, balancing risk with the potential for higher returns.
The Appeal of Real Yields and TIPS
A significant part of Davis's strategy involves investing in real yields and Treasury Inflation-Protected Securities (TIPS). He notes the attractiveness of 10 and 30-year TIPS, given the current financial conditions and inflation expectations. Davis's approach has evolved from a bearish stance over the past two years to a bullish outlook for 2024, indicating a shift in market dynamics.
Inflation, Employment, and the Bond Market
Drawing parallels with the inflationary patterns of the 1970s, Davis suggests that the current inflation scenario may see multiple peaks. He emphasizes the 'stickiness' of services and wages due to high employment levels, arguing that a significant reduction in inflation will likely require an increase in unemployment. This perspective is critical for understanding the bond market's trajectory in the near future. He aptly points out that all of the wage demands negotiated during some of this year's large labour strikes, for example, most notably the United Auto Workers' and Hollywood strikes' settlements, have yet to be implemented in January 2024.
The Discrepancy in Treasury Supply and Dealer Capital
Davis highlights a critical market dynamic: the fivefold increase in Treasuries since 2007, contrasted with only a twofold increase in dealer capital. This imbalance has led to broader market moves and could potentially push the 10-year Treasury yield back up to 5%.
The Case for Active Management
In the current market environment, Davis strongly advocates for active management. He believes that identifying discrepancies between market expectations and forecasts presents unique opportunities. Tactical trades and structural investments in real yields and credit are key components of this active management approach.
You can see the whole Bloomberg Surveillance interview with Earl Davis and more here (starting around 1:29:00):
