Quarterly Global Asset Allocation Portfolio Outlook | Q4 2024

Reallocating to Defensive Assets Amid Lower Yields

Over the past three months, we've observed further asset price increases alongside declining yields, leading us to expect lower returns going forward. As a result, we're taking steps to de-risk our Model Asset Allocation, believing that the current environment won't reward additional risk-taking.

We're now increasing our positions in government bonds and investment grade credit, moving both to an Overweight stance, while trimming our exposure to real estate and commodities to Neutral. Regionally, we prefer UK and emerging market (EM) assets, and we're further boosting our Japanese yen (JPY) exposure through hedges from the US dollar (USD).

The good news? We expect a rapid decline in central bank interest rates over the next 12 months, with markets already pricing in around 240 basis points of cuts from the Fed. However, the bad news is that some cyclical assets have likely priced this in, just as we believe the global economy is slowing. There are also potential geopolitical and election risks on the horizon, though we expect them to have a limited long-term impact. Optimisations based on our 12-month projected returns lead us to adopt a more defensive approach, though we’re careful not to overdo it.

Fed Rate Cut Predictions and Forecasts for 2024

What should we expect from the Fed? With over 40 central banks cutting rates in 2024, all eyes are on the US Federal Reserve. The Fed is likely to announce its first rate cut on September 18, 2024, with the only debate being whether it will be 25 or 50 basis points. Given that core PCE inflation is around 2.6% and economic growth is slowing, a cut seems almost certain.

Market expectations for Fed cuts have surged, with futures indicating 110 basis points of cuts by the end of 2024 and 235 basis points within a year. While this might sound dramatic, it’s consistent with past easing cycles, where the Fed has typically cut rates by about 180 basis points in the initial six months.

The question is: how low will rates go? Markets anticipate a 240-basis point drop over the next year, pushing rates to around 3.10%, with a possible low of 2.90%. The Taylor Rule suggests a “neutral” rate should be around 4% if inflation is 2%. However, with the Fed’s June 2024 median estimate at 2.8%, we expect these forecasts to rise as recent biases diminish.

Turning to the slope of the yield curve, Figure 15 highlights an intriguing trend: since 1980, 10-year yields have generally exceeded policy rates by an average of around 1.15% to 1.30%. This historical pattern suggests a “normal” 10-year yield range of 4.00% to 5.00%. Whether we hit this range will depend on the accuracy of our or the FOMC’s predictions about the neutral Fed policy rate. If the Fed’s policy rate moves in line with historical trends, we could see 10-year yields settling comfortably within this expected range.

Impact of US Elections on Financial Markets: Key Candidate Differences

We generally believe that elections don’t have a lasting impact on financial markets under normal circumstances. Our historical analyses challenge the conventional wisdom, suggesting that Democratic presidents have often been linked with better economic performance and stronger stock markets. Additionally, there appears to be no clear relationship between corporate taxation rates and future stock market returns.

Nevertheless, we’re keeping a close eye on the upcoming US elections. The candidates present some distinct contrasts: Donald Trump seems frustrated by his limited influence over the Fed, while Kamala Harris is likely to uphold its independence. Trump is expected to advocate for lower taxes, both personal and corporate, whereas Harris appears more focused on redistribution.