Fourth Quarter 2024

MARKET OUTLOOK / STRATEGY

Fourth Quarter 2024

As we transition into the next administration, market sentiment suggests that the economic environment will remain robust, with markets delivering positive performance, albeit at lower rates of return. Our outlook aligns with this view, although we are concerned about potential outlier scenarios that might come into play.  The levels of uncertainty and optimism are high and we anticipate episodes of volatility throughout 2025. Geopolitical risks, fiscal and monetary policy uncertainty and potential for missteps are elevated, and wealth inequality remains a persistent issue. We will remain vigilant.

U.S. economic growth has exceeded expectations, and our forecast suggests it will remain above the Federal Reserve’s 2% forecast. Consumption should continue to be a significant contributor, driven by increased wealth, particularly among households with significant financial assets. Business spending is also projected to accelerate due to expectations of reduced regulation and investments in AI, which could boost productivity in the near term. However, policies on tariffs and immigration, along with challenging conditions in Europe and Asia, could dampen economic enthusiasm.

The FOMC and investors have refocused on inflation concerns, as their mandate of maximum employment seems to have been achieved.  While risks will resurface around implications of immigration policies and artificial intelligence on the labor market, they are not yet significantly in play.  Meanwhile, Core PCE has settled above the Federal Reserve’s 2% forecast, with service costs inflation declining slower than expected and goods prices starting to rise. The Fed’s inflation risk forecasts have shifted from balanced to concerns about it being higher, leading them to reduce expectations from four to two rate cuts in 2025. We project the U.S. 10-year Treasury yield to range between 3.5% and 5.0% over the next 12 months, reflecting potential growth and inflation volatility. We plan to maintain duration positioning in a tight range around the Index.

Corporate fundamentals are projected to remain strong. Economic growth should keep margins firm and support current leverage levels. Corporate supply is forecasted to be flat to slightly higher, with healthy demand from a broad investor base. Under the new administration, M&A activity is expected to increase significantly.  Security selection will be key as transactions can be positive or negative for credits. Attractive yields and low near-term recession risks contribute to a positive outlook for the sector. We maintain a modest credit overweight, acknowledging that credit spreads are rich, and outlier scenarios are possible. We believe there will be opportunities to generate alpha through new issues, carry and security selection, as our central expectation is for credit spreads to trade in a range.

We hold a modest overweight in the MBS sector.  Our view is supported by attractive valuations and opportunities to enhance returns through security selection. The sector is poised to benefit from a projected rise in bank demand in 2025 as regulatory constraints ease, though elevated interest rate volatility remains a potential headwind. In the ABS sector, we maintain a sizable overweight which reflects the securities’ strong structural protections and compelling relative value at the front end of the curve.  For non-agency CMBS, our approach remains opportunistic and selective, balancing the risks associated with the office sector against structural protections, our ability to add value through security selection and attractive valuations.