Soft landing still possible but global economy ‘not out of the woods yet’: Robeco

While market analysts appear to have “fully embraced a Goldilocks scenario” for the global economy, recognising central banks’ efforts to dampen skyrocketing inflation as largely effective, global asset manager Robeco has cautioned that it is still “too early to declare victory” with “plenty of room for disappointment” for global credit market investors.

Releasing its latest Credit Quarterly Outlook (for the Q1, 2024 period) today, Robeco said the market appears, rather hopefully, to be “pricing in a best-case scenario” for the global economy.

With US treasury bond rates believed to have peaked last October, US markets, it said, are now priced for a Goldilocks scenario.

The optimistic assessment furthers the consensus of last quarter’s market Outlook, with analysts at the time predicting a soft landing and an effective ‘abandonment’ of bear market forecasts.

Robeco said that it agreed, at least, that the odds of a recession have likely diminished, with monetary policy largely doing its job to stem inflation without entirely stymying growth.

Indeed, despite experiencing “one of the sharpest hiking cycles in modern history”, economies in Europe and the US appear to have “moved through it without being derailed”, it said.

The firm added: “Spreads have moved significantly, and parts of the US credit markets are in or shifting towards the bottom decile in valuation.”

However, the asset manager has cautioned that risks have “not abated”, with a mid-90s style economic bounce back (recognised as the only time the economy did not end in recession following aggressive central bank rate hikes) unlikely to play out.

Robeco said such bottoming out of the credit market valuations is typically seen “at the end of long bull markets and not in an environment like this”.

“Markets are priced on very high expectations and that means there is plenty of room for disappointment,” the firm said. “It will take a more serious slowdown or recession to move markets more materially” – the chances of which, it said, are still “considerable… given the slow transmission of the tightening cycle”.

The US market, in particular, is under-pricing risk considerably (with current market spreads already below year end 2024 targets), Robeco argued, “and is now completely disregarding the odds of a recession or slow-down”.

Ultimately, the fund manager warned that signals from market data remain “conflicting” and next to impossible to predict. Market analysts, it said, have been misled “many times in the past two years”.

“We maintain our cautious view for now. We continue to believe the impact of a monetary cycle is difficult to predict due to the slow transmission mechanisms; historically, this has proven to be almost impossible to get right.”

Further, Rebeco argued that high interest rates will persist for some time, and will continue to hammer the bottom lines of highly leveraged small and medium businesses. For well-capitalised, ‘investment grade’ companies, the effects of this will be minimal, it said.

Neutral on credit

Robeco said that, with the current uncertainty in the credit market, it is “comfortable holding a more neutral overall position, while taking bottom-up risk in those parts of the market where we think risk-return is appealing”.

“We are slightly long beta in investment grade and firmly hold our conservative positioning in high yield,” the firm said.

It stressed that “strong issuer selection and buying quality carry” provides the best value for investors in current credit markets.

“We remain comfortable with ‘investment grade’ in general, and more cautious on high yield, especially in the lower-rated part.”

Overall yields in investment grade credit are still at attractive levels, it said, with good return prospects – one that can effectively “compete with many other more risky classes”.

Additionally, it said, the banking sector globally remains “relatively cheap”.

“In particular, senior bank bonds have generally lagged the market and can still be considered on the cheap side.”

Lower-rated companies, however, will continue to “decompress”, Robeco said, as they struggle to refinance or risk default.

“CCC-rated companies are already underperforming and given their leverage, this is likely to continue”.

Pressure on businesses from high interest rates “is still present”, with rates – despite their considerable decline over the last few months – at the “same level as the start of 2023”.

“The effect of this is not yet that visible in public bond markets as companies have fixed rate debt,” Robeco said.

“Looking at small and mid-sized companies or high yield companies that finance themselves using floating rate bank loans, we are seeing the effect of higher rates as the transmission is faster. It is not surprising that within these companies, defaults are surpassing those of the bond market.”

With the market attracting considerable hype, Robeco urged credit investors to adopt a more cautious investment approach.

“We often see markets overshoot in a positive sentiment environment.

“Not all companies are equal, so it is important to remain vigilant and invest in those companies where risk/return is properly balanced.”