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    MARKET PULSE 
    |
    MAY 2023

    MARKET PULSE | MAY 2023

    Macro Views

    China Growth

    GIR expects 2023 China growth at 6.0%, but we believe the growth impulses from reopening and policy support will be front-loaded this year. Going forward, we think the two most important factors determining the robustness of China’s recovery are 1) limiting the growth drag from the property sector and 2) translating household’s excess savings into consumption. For context, the household savings rate is currently at 33.5%, substantially above trend. Read More

    Monetary Policy

    GIR has removed its June Fed rate hike call following tighter credit conditions. They expect the terminal rate of 5.00%-5.25% will be reached in May. For the ECB, they added back a 25bp hike in July for a terminal rate of 3.75% as strong underlying inflation indicators remain more concerning than banking tensions. GIR expects the BoE to also deliver a 25bp hike in May as wage growth reaccelerates. Read More

    US Debt Ceiling

    The Treasury has stated it may exhaust its cash by early June, though variable tax receipts could push the deadline to late July. Regardless, we do not expect a US debt default. The closer the deadline gets, the more likely a short-term debt ceiling increase happens. Read More

    Artificial Intelligence

    In our view, roughly two-thirds of US jobs are exposed to some degree of AI automation, with high exposures in administrative and legal and low exposures in construction and maintenance. Still, the creation of new jobs has historically offset worker displacement from automation, with technology-driven new jobs accounting for 85% of the employment growth over the last 80 years. Read More

    Market Views

    US Equities

    US stock performance has been strong this year, with a handful of long-duration stocks benefitting from a steep decline in interest rates. Specifically, just seven names drove nearly 90% of the S&P 500’s 7.5% return in 1Q. This lack of breadth may undermine the sustainability of this year’s rally. In our view, capped valuations in conjunction with moderating earnings growth should limit further index-level gains. Read More

    EM Equities

    Despite a favorable backdrop of strong global equity performance, lower US rates, and a weakening US dollar, EM equities have underperformed relative to their DM peers. Still, we remain firm in our view that optimistic earnings estimates in more durable, consumer-oriented categories, alongside further US dollar deterioration, reaffirms a path for potentially strong EM performance in the longer term. Read More

    FX

    Recent bilateral trade agreements have increased concern over de-dollarization. Despite these developments, we do not expect a challenger such as the Chinese yuan to replace the US dollar as the world’s reserve currency. China’s current account surplus incentivizes that limits be placed on yuan appreciation while other countries’ foreign exchange pegs require adequate dollar reserves be held. Moreover, deep US capital markets may provide liquid asset classes to invest reserves, potentially incentivizing foreign central banks to hold US dollars. Read More

    Money Markets

    Ultra-short fixed income fund inflows were pronounced following March’s bank stress. The yields they still offer are difficult to contend but one key threat persists: reinvestment risk. We believe many investors stand to benefit from barbelling short-dated bonds with pockets of the market that have historically outperformed following the conclusion of Fed hiking cycles, such as HY municipal bonds. Read More

    Duration: Why, When, and How

    Our appetite for increasing duration in fixed income has grown as we near the end of the Fed’s rate hiking campaign. In our view, the risk asymmetry is appealing as higher yields on the long end may counterbalance further rate upside. As such, we believe the decision to add back duration is best addressed now through municipal bonds. History has rewarded early duration movers in the past six hiking cycles, with municipal bonds also outperforming US T-bills following historical peaks in policy rates.

    WHY: SHORT RATES FELL FASTER THAN LONG RATES AFTER THE LAST RATE HIKE

    The potential benefits of owning short maturity bonds today seem irrefutable. However, we believe reinvestment risk is upon investors as monetary policy enters its final stretch. We believe investors should consider turning their attention to securing future yields over current ones as historical post-Fed tightening cycles have led to precipitous declines in front-end yields. We believe a similar dynamic might hold this time around, creating an opportune time to add back duration.

    Source: Bloomberg and Goldman Sachs Asset Management

    WHEN: EXTENDING DURATION EARLY HAS HISTORICALLY PROVED REWARDING

    The early bird gets the worm. Being early on a duration call may offer upside for investors. With Fed funds rate near its peak, we believe the risk asymmetry has turned more favorable for lengthening duration. Market pricing reflecting limited rate upside may lessen future bond price sensitivity, while a fall in rates may bump returns higher. Ultimately, a high starting yield may help lock in attractive returns, with early duration extension adding 560bps more in alpha versus being late.

    Source: Barclays and Goldman Sachs Asset Management

    HOW: MUNIS HAVE POSTED ATTRACTIVE RETURNS AT HIKING CYCLE END

    In our view, lengthening duration is particularly effective with municipal bonds. At the conclusion of the last three Fed hiking cycles, returns in high yield and long-duration municipal bonds have outperformed US T-bills on average by 4.7pp and 6.0pp, respectively. Light muni positioning has boosted yields relative to US Treasuries, and our expectation for a pick-up in summer flows against tight supply may invite another performance tailwind.

    Source: Bloomberg and Goldman Sachs Asset Management
    VIEW LESS DISCLOSURE

    Top Section Notes: Chart shows the 2-Year US Treasury and 10-Year US Treasury yields since January 1, 2000. Shaded circles are centered on the month-end dates of the final hike of the Federal Funds rate during the past three Fed hiking cycles: May 31, 2000, June 30, 2006, and December 31, 2018. Middle Section Notes: As of March 31, 2023. The last months of the prior six Fed hiking cycles used are August 1984, February 1989, February 1995, May 2000, June 2006, and December 2018. Past performance does not guarantee future results, which may vary.

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