August 2024 market volatility: a fixed income perspective

• Asian and Singapore credits have shown relative resilience amid the steep early August 2024 global selloff.
• There is currently a more balanced assessment between inflation and growth considerations by the Fed, paving the way for monetary easing to commence.
• Our fixed income portfolio managers are navigating the present environment by extending duration and limiting exposure to the higher beta names.

Balancing inflation and growth considerations amid shifting central bank policies

Earlier this year, expectations for major central bank easing, including by the Federal Reserve (Fed), were tempered. This shift in anticipation reflected a macroeconomic landscape where markets reacted to stronger growth signals and unexpected inflation stickiness, which cautioned central banks against initiating their easing cycles prematurely or reducing rates too aggressively.

Recent developments suggest a more balanced alignment of growth and inflation risks, paving the way for central banks to lower policy rates. Notably, the second consecutive low U.S. core CPI print in June and a softening U.S. labour market, bolsters the case for a potential easing in September, with prospects for more decisive monetary policy adjustments ahead. The Fed’s focus is shifting from being centred solely on inflation to a more balanced consideration of both inflation and employment risks, reflecting its growing confidence that inflation is on the right path. The extent of rate cuts for the remainder of the year will depend on incoming data, with growth-related developments likely playing a more significant role compared to inflation indicators.

In early August, we observed heightened market volatility which was triggered by a confluence of factors: the Bank of Japan’s unexpected hawkish policy shift, leading to a sharp spike in the yen and the unwinding of long-standing carry trades funded by the currency; the subsequent triggering of stop-loss orders; weaker-than-expected U.S. July non-farm payrolls; and higher US unemployment. Seasonal factors, such as reduced liquidity during the summer holidays, also contributed. This culminated in a perfect storm, with market price actions reflecting shifts in risk appetite rather than underlying economic fundamentals.

Notably, the credit markets, including those in Asia and Singapore, have demonstrated relative resilience. We do not anticipate significant widening of credit spreads, as our central view suggests that while the U.S. economy is slowing, there are no immediate signs of a severe downturn. However, given the current market volatility, it is crucial to manage risk in the near term to protect investment performance during turbulent periods.

Our current strategy focuses on managing short-term risks while enhancing portfolio resilience and avoiding overexposure to higher-beta names. Most of our portfolios have been extending duration, and we plan to continue seeking opportunities to extend duration further in anticipation of Fed easing. However, given the recent sharp rate rally, the current risk-reward profile for extending duration is not favourable. Moreover, we believe the Fed will not aggressively ease monetary policy unless there is strong evidence of a U.S. economic downturn or a systemic risk event. We anticipate yields to remain highly volatile as economic fundamentals take a backseat. Concurrently, we are looking for opportunities to capitalise on market dislocations, such as from the indiscriminate selling of quality securities, or to realise profits on selected investments that have performed well.

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