The common wisdom that sharp hiking cycles have always resulted in recession is being challenged as more economists are moving towards a soft-landing scenario for the US economy, global asset manager Robeco has noted.
“And indeed, globally we are currently seeing inflation moving down,” the firm observed in its latest market outlook.
“Economies are cooling, jobs growth has been on the decline, and activity in the services sector has been slowing, whilst activity in the manufacturing and construction sectors has been dormant for a while, hovering at recessionary levels.
“US economic data, and more importantly inflation, is finally trending lower.”
The Federal Reserve’s dovish pivot – the central bank having recently acknowledged they are near or at the end of their hiking cycle – seems to have cemented the market view of a soft landing, according to Robeco.
“Does this mean we are out of the woods yet? The market seems to think so, but we think it is too early to declare victory,” the firm said.
“Indeed, recession odds do seem to have come down. However, signals from data are conflicting and have misled us many times in the past two years.”
As such, Robeco confirmed that it is maintaining a “cautious” view for now, conscious that the impact of a monetary cycle is difficult to predict and that historically, it has proven to be “almost impossible to get right”.
The fundamentals
Looking at corporate fundamentals, the asset manager said that as inflation is trending down, pricing power seems to be following suit.
“As wages lag, we think margin pressure could intensify going forward,” the firm noted.
Namely, 2023 saw sectors such as technology and heavy industrials battle with margin compression, but “scarred” by the difficulties to find staff and bolstered by the healthy buffers accumulated during COVID-19, Robeco explained that some companies have been willing to let margins slide over shedding labour costs.
“Ultimately, corporate fundamentals are key to being able to refinance debt, especially in high yield. Does this mean we are extremely pessimistic? No. Many companies started this cycle in a healthy state and can withstand some headwinds.
“We do expect dispersion to grow, not just in high yield but in investment grade too. If we look at the rating agencies, we see them placing negative outlooks on an increasing number of companies, yet they also maintain many positive outlooks.”
Robeco also acknowledged the still present pressure from higher rates, noting that financing costs for companies will still rise materially.
“The effect of this is not yet that visible in public bond markets as companies have fixed rate debt,” Robeco said, but noted that as more companies in the bond market need to refinance in 2024, “these effects will soon become more visible”.
“For high-leveraged companies, higher rates will have a material impact on a company’s financials. For investment grade companies, the effects will, in most cases, be small. However, here we are seeing companies in need of capital allocation adjustments as well. For example, infrastructure companies like telecom towers and renewable energy need to adjust their balance sheets for higher rates,” Robeco said.
Ultimately, the firm said there are “clearly winners and losers in this environment”.
