Third quarter 2023–Macroeconomic update

CONTRIBUTORS

Paul Mielczarski

Head of Global Macro Strategy,
Brandywine Global

Preview:

Bond yields rise as inflation falls

One of our key macroeconomic calls for 2023 was that US inflation would fall toward the Federal Reserve’s (Fed’s) 2% target. That seems to be playing out with the core Consumer Price Index (CPI) averaging 0.2% month-on-month for the past three months, the equivalent of a 2.4% annualized rate. We expect this trend to continue in the coming months. This time last year, core inflation was above 6%.

Monetary policy tightening impact muted or delayed?

Brandywine Global’s investment framework is based on the idea that large moves in bond yields and currencies create economic responses that ultimately lead to cyclical mean reversions. So far, the US economy as well as equity, credit, and real estate markets have held up remarkably well in the face of a 250 basis point (bp) increase in US 10-year real yields over the past 18 months.

Estimating the lag between monetary tightening and its impact on growth is difficult in a more “normal” economic environment. It is particularly challenging in the current economic cycle, which has seen a combination of massive monetary and fiscal swings, COVID-related consumption shifts and supply-side disruptions, and a 1970s style commodity price shock. Estimating the impact of each individual shock and the extent to which the shocks amplify or offset one another is particularly challenging.

Strategy implications

There is a compelling case for being long US fixed income. Core inflation looks to be on track to reach the Fed’s 2% target. Labor markets are rebalancing rapidly, which should result in lower wage growth. Global growth is rolling over, led by China and Europe. While US growth has been resilient so far, we expect growth to slow as monetary policy lags kick in. US real yields are high relative to trend GDP growth. Fixed income is attractive relative to equities, with US investment grade bond yields above the US equity forward earnings yield for the first time in 20 years, based on the Bloomberg US Corporate Bond Index versus the S&P 500 Index.

Read the full paper to learn more.

Definitions:

The Bloomberg US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non- US industrial, utility, and financial issuers.

The S&P 500 Index is a broad measure of U.S. domestic large cap stocks. The 500 stocks in this capitalization-weighted index are chosen based on industry representation, liquidity, and stability.

A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

WHAT ARE THE RISKS?

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

This document is intended to be of general interest only. This document should not be construed as individual investment advice or offer or solicitation to buy, sell or hold any shares of fund. The information provided for any individual security mentioned is not a sufficient basis upon which to make an investment decision. Investments involves risks. Value of investments may go up as well as down and past performance is not an indicator or a guarantee of future performance. The investment returns are calculated on NAV to NAV basis, taking into account of reinvestments and capital gain or loss. The investment returns are denominated in stated currency, which may be a foreign currency other than USD and HKD (“other foreign currency”). US/HK dollar-based investors are therefore exposed to fluctuations in the US/HK dollar / other foreign currency exchange rate. Please refer to the offering documents for further details, including the risk factors.

The data, comments, opinions, estimates and other information contained herein may be subject to change without notice. There is no guarantee that an investment product will meet its objective and any forecasts expressed will be realized. Performance may also be affected by currency fluctuations. Reduced liquidity may have a negative impact on the price of the assets. Currency fluctuations may affect the value of overseas investments. Where an investment product invests in emerging markets, the risks can be greater than in developed markets. Where an investment product invests in derivative instruments, this entails specific risks that may increase the risk profile of the investment product. Where an investment product invests in a specific sector or geographical area, the returns may be more volatile than a more diversified investment product. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from use of this document or any comment, opinion or estimate herein. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any share class with “(Hedged)” in its name will attempt to hedge the currency risk between the base currency of the Fund and the currency of the share class, although there can be no guarantee that it will be successful in doing so. In some cases, investors may be subject to additional risks.

Please contact your financial advisor if you are in doubt of any information contained herein.

For UCITS funds only: In addition, a summary of investor rights is available from here. The fund(s)/ sub-fund(s) are notified for marketing in various regions under the UCITS Directive. The fund(s)/ sub-fund(s) can terminate such notifications for any share class and/or sub-fund at any time by using the process contained in Article 93a of the UCITS Directive.

For AIFMD funds only: In addition, a summary of investor rights is available from here. The fund(s)/ sub-fund(s) are notified for marketing in various regions under the AIFMD Directive. The fund(s)/ sub-fund(s) can terminate such notifications for any share class and/or sub-fund at any time by using the process contained in Article 32a of the AIFMD Directive.

For the avoidance of doubt, if you make a decision to invest, you will be buying units/shares in the fund(s)/ sub-fund(s) and will not be investing directly in the underlying assets of the fund(s)/ sub-fund(s).

This document is issued by Franklin Templeton Investments (Asia) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.

Unless stated otherwise, all information is as of the date stated above. Source: Franklin Templeton.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.