Friday Investors Club | AI investment case intact despite mixed headline results (11:18)

CIO tech expert Sundeep Gantori joins CIO's Wayne Gordon and Daisy Tseng to unpack the tech earnings season thus far, how much China tech could benefit from the AI theme, and how to manage tech exposure in a balanced portfolio.

Thought of the day

An auction of the 30-year US Treasuries was the strongest in over a year, with USD 25 billion of bonds issued 2 basis points below the pre-sale yield. This followed a solid auction of 10-year bonds the day before, helping to ease concerns that rising US government debt is leading to oversupply.

Despite the positive auctions, however, Treasuries overall had a weak day on Thursday. The yield on the 10-year US Treasury closed at 4.17%, up 7 basis points from a day earlier. Since late December, the yield has climbed nearly 40 basis points.

The rise in yields reflects the shift in investor expectations over the timing of expected Federal Reserve rate cuts. Last week, Fed Chair Jerome Powell pushed back against a March cut at the press conference after the policy meeting. Comments from a number of Fed officials this week also suggested that they don’t see an urgent case for lowering interest rates. Separately, the US economy appears to be holding up stronger than many expected, with the number of new jobs growing at the fastest pace in almost two years last month.

But we continue to believe that easing is on the agenda this year, and that quality bonds remain attractive in the current environment. In fact, they should hold an important place in investors’ portfolios.

The Fed is still on track to start cutting rates this year. We view indications from the Fed that they won’t start rate cuts in March as largely a non-event, as we expect a first cut in May. Minneapolis Fed Chief Neel Kashkari said the US central bank is not looking for “better” inflation data, just “additional inflation data,” and that he thinks two to three cuts will likely be appropriate this year. We think it’s important not to lose sight of the big picture, which is that continued disinflation should allow the central bank to start easing this year. This is a significant change in the investment landscape, so we think it’s less important whether the Fed cuts three, four, or five times this year. Any of these scenarios should be a positive macro outcome for bonds, and we see the 10-year Treasury yield falling to 3.5% by the end of this year.

Market risks remain amid fluid geopolitical events. While mediators are scrambling for a ceasefire between Israel and Hamas, tensions in the Middle East remain elevated. Israeli Prime Minister Benjamin Netanyahu has rejected Hamas’ latest offer, and Hamas urged Palestinian armed factions to go on fighting. The US has also continued with strikes against Iran-backed armed groups in the region in retaliation over a deadly attack on US troops. In our base case, continuous attacks and tensions in the Middle East in the coming months may only have a moderate global inflationary impact, but bouts of market volatility can be expected. We think quality bonds are well positioned to help protect against downside risks.

The risk-return proposition of quality fixed income is attractive. Historically, it has paid to be proactive and switch from cash to bonds well ahead of the first interest rate cut, as cash typically underperforms in the later stages of rate-hiking cycles and during rate-cutting cycles. With the reinvestment risk of holding too much cash becoming apparent as rate cuts draw nearer, we see particular value in quality bonds as returns are still likely to be positive even in a Goldilocks scenario, which is the least favorable for the asset class.

So, we retain our most preferred rating on quality bonds in our global portfolios despite likely volatility in yields in the near term. In our base case, we expect 8.5% returns for high-quality, medium-duration bonds this year.