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Are there more surprises? That’s top of mind for financial markets as Silicon Valley Bank’s spectacular collapse set off a global banking panic. That 167-year-old Credit Suisse was forced into a marriage over the weekend only adds to the unease. The end of an era of ultra-low rates is ending badly, and central banks the world over are working furiously to contain the damage. But investors are acting like they’re from Missouri: they want to see that the remedies work. Until then, expect more volatility.

Forget everything else. This week is all about the Fed. At this writing, futures are pricing a quarter-point hike, but those odds are falling and futures have been all over the place. The fear is if the Fed holds steady, markets may interpret the inaction as a sign the situation is worsening. On the other hand, a year into a record tightening cycle, things are starting to break. So, maybe it’s best if the Fed stands back? We won’t get an answer until 2 p.m. Wednesday, a lifetime in today’s market.

Staying defensive across our investment universe amid all the volatility. In domestic Equities, that means hefty exposure to Value/dividend payers and well-below normal exposure to Growth. We remain overweight Developed & EM International on valuations and fundamentals. We like EM & Developed International in Fixed Income, too (the latter more of a currency call) but are underweight most credit sectors. Trade finance, bank loans and residential MBS offer tactical opportunities, as do duration and the yield curve. In Liquidity, we believe substantial cash exposure and short-term products continue to work, with a bias toward moving out the curve.

What

Positioning

March 20, 2023

Weekly

October 2022

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Our fixed-income committees are slightly long benchmark duration and effectively neutral the yield curve and the U.S. dollar. As far as sectors, our portfolio models are underweight investment grade, high yield and overweight international developed emerging markets, U.S. Treasuries and agencies, with tactical positioning in residential MBS, where we currently are overweight as the coupon is attractive. We expect company-specific results to drive corporates including high yield in a mostly difficult earnings environment. We believe municipal bonds are offering an improved risk/return balance for investors in spite of a drop in February.

Fixed income

We continue to prefer defensive dividend-paying stocks and are underweight rate-sensitive growth stocks. We’re more constructive on international large cap and emerging markets. We remain defensive in the U.S., preferring value and dividend-oriented equities even while acknowledging January’s rally in riskier categories. We believe more rate and economic pieces need to be in place for a value-to-growth rotation to have legs.

The one-year anniversary of the invasion of Ukraine passed with estimates of nearly a quarter million dead and the conflict may be far from over. Meanwhile, the economic outlook for Europe has improved in the last few months. Natural gas prices are sharply lower from last summer’s peak, abetted by mild winter temperatures. But preparedness for the war’s fallout and the long tail of the Covid-recovery dynamics also have underpinned economic resilience on the continent. European governments targeted fiscal measures to shield households from large increases in utility bills, and made sure that gas storages were plentiful before the winter season. We now expect eurozone real GDP growth of 0.6% in 2023, up from last winter’s projections. Going forward, the eurozone cycle is sensitive to what happens in the U.S. If the U.S. falls into a recession in the second half of 2023, the eurozone likely will follow with a lag that typically is in the range of two to three quarters, presenting a more sobering picture for the eurozone and the global economy overall later in 2024. Despite geopolitical drama over balloons and potential support of the Russian war effort, China’s rapid reopening and abandonment of Covid lockdowns has consensus expecting a marked improvement in growth and a return to normal. To drive the recovery, China has loosened the regulatory net on enterprises and boosted the money supply, and has policy options including direct payments to consumers and quantitative easing used by other countries post-pandemic at its disposal. China's reopening may lift global growth, but we expect a limited and temporary impact as much of its focus will be internal.

February provided support to the higher-for-longer camp as inflation remained sticky, seasonally adjusted January jobs surprised to the upside and fed futures adjusted toward a higher terminal rate around 5.25-50%. Robust January job growth, consumer spending and services activity, along with higher-than-expected PCE and CPI prints, were the culprits. The good news is bad news conundrum persists, keeping pressure on the Fed to cool the economy the hard way. Consensus now sees a third rate hike in June with any potential rate easing pushed into 2024. What’s different this time? The past may not be prologue—the unique economic environment spawned by unprecedented fiscal and monetary stimulus due to a pandemic may not align with traditional analysis and forecasts. Current equity markets appear to be underpricing recession risks, while fixed-income markets are increasingly pricing one in. This suggests the rocky landing scenario we’ve been presenting for a while, one that sees a slowdown rolling through individual parts of the economy non-sequentially, could well be what happens. Not ultimately a technical recession, but plenty of bumps along the way.

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The January rally in developed and emerging markets also corrected in February. Rising prospects for a higher-for-longer Fed fueled a rally in the dollar, partially reversing a four month sell-off. This created headwinds for some emerging markets despite China’s reopening. At the same time, valuations are more attractive internationally, and the range and severity of inflation varies across markets. While global equity returns were highly correlated in 2022, 2023 has the potential to provide nuanced pockets of opportunity driven by growing demand in a reopening China and a USD that shows signs of coming off a recent surge going forward.

Domestic equity markets cooled in February with results varying across categories, with small caps and the Nasdaq Composite faring better than the large-cap Dow and S&P 500. Major indexes remain much improved from their 2022 lows, but the February retrace reflected a return to fundamentals as fourth-quarter earnings underwhelmed. The macro environment remains confounding. Positive economic prints are negatives with equity markets vulnerable to continued Fed hawkishness. Volatility throughout February added to gloomy predictions about new market bottoms, but we have established our 2024 outlook with a broad range for the S&P 500 and believe earnings and valuations still have significant downside to work through. Markets don’t like uncertainty and a unique combination of factors is in play with resolution a ways off.

International Equity

During the last two weeks of February, the 2-year Treasury yield jumped 70 basis points to 4.8%, while the 10-year yield rose by more than 50 basis points to 3.9%. The respective moves pushed the 2s/10’s yield curve inversion to 90 basis points, the steepest inversion since 1982. The sharp move higher in yields has been driven by a consistent stream of hotter-than-expected economic data, prompting markets to shift from underpricing to pricing in, if not overpricing, the Fed’s hawkish narrative. Don’t fight the Fed is a market mantra for a reason. There are multiple factors supporting opposing directions in yields and contributing to recent price volatility. In short, persistent inflation likely drives further central bank tightening, potentially driving rates higher particularly on the shorter end, while subsequent growth deceleration, and possible geopolitical events, could push longer rates lower. Globally, we expect central banks to become less hawkish as inflationary pressures cool. Commodity prices are anticipated to remain robust, but global supply chains continue to heal with an easing of bottlenecks. The awaited reopening of China is a plus for both developed and emerging market debt.

Positioning

Source: Fred®, U.S. Treasury, Bloomberg

As of 2/28/2023 4.52% 4.65% 4.88% 5.17% 5.02% 0.84% 4.50%

Short-term yields SOFR 30-Day Avg 1-month T-Bill 3-Month T-Bill 6-Month T-Bill 1-year T-bill MMDA Avg First Tier IS Avg

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Asset-backed securities

Liquidity

iquidity

Source: Bloomberg

As of 2/28/2023 0.41% -0.15% 2.47% 0.43%

Total returns U.S. Aggregate Global Aggregate U.S. Corporate High Yield S&P Municipal Bond

Fixed Income

As of 2/28/2023 3.40% 7.89% 9.45% 5.87% 0.92%

Total returns S&P 500 Russell 2000 NASDAQ MSCE EAFE MSCI EM

Equities

Percentages as of 2/28/2023 Source: Trading Economics.

Jobless Rate 3.40 6.60 5.50 2.50 3.70

Inflation 6.40 8.60 2.10 4.30 10.10

Interest Rate 4.75 3.00 3.65 -0.10 4.00

GDP QoQ 2.70 0.10 0.00 0.20 0.00

GDP YoY 0.90 1.90 2.90 0.60 0.40

Country United States Euro Area China Japan United Kingdom

Macro Dashboard—Inflation roiling developed markets

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March 2023

Monthly

Maintain shorter durations while also capitalizing on opportunities slightly further out the curve. Maintain a general preference for higher-quality securities given risk of an economic slowdown. Take a more balanced approach to floating-rate securities leading up to a Fed pause.

We expect the Fed to move forward with rate hikes at the next several meetings before pausing, with the recent reacceleration in inflation data posing some risk to that forecast. For now, investing incrementally shorter can be beneficial, but we are finding more attractive opportunities in the ultrashort space, particularly in higher-quality securities. Three themes are guiding our investment views in the space:

Positioning

Fed futures contracts still appear to be pricing cuts to the federal funds target rate at the end of 2023, but we don’t expect that to happen. Work still needs to be done to get inflation under control. We are keeping our finger on the pulse of the developing U.S. debt limit debate, but ultimately believe it will be resolved and do not expect the U.S. government to default on its debt obligations.

Percentages as of 2/2/2023 Source: Trading Economics.

Jobless 3.50 6.50 5.50 2.50 3.70

Inflation 6.50 9.20 1.80 4.00 10.50

Interest Rate 4.75 3.00 3.65 -0.10 4.00

GDP QoQ 2.90 0.10 0.00 -0.20 -0.30

GDP YoY 1.0 1.90 2.90 1.50 1.90

Country United States Euro Area China Japan United Kingdom

Macro Dashboard—Inflation roiling developed markets

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United States

Source: Bloomberg

As of 2/28/2023 0.41% -0.15% 2.47% 0.43%

Total returns U.S. Aggregate Global Aggregate U.S. Corporate HY S&P Municipal Bond