Markets pricing in a soft landing
The risk of a soft landing is increasingly being priced into markets, according to Zenith Investment Partners.
A soft landing is characterised by lower inflation, no recession, only modest easing during the second half of 2024, and bond yields in the range of 3.5–4.25 per cent.
Zenith head of asset allocation, Damien Hennessy, said markets have been heading towards the likelihood of a soft landing for the past three months.
“Equity markets have held up reasonably well, while credit spreads have tightened a little bit. Markets are starting to price in a soft landing, with inflation returning to the 2–3 per cent range in 2024/25,” Hennessy said.
In the last financial year to 30 June, the ASX 200 returned 10 per cent while the S&P 500 returned 15 per cent.
He gave a wide range of four possible outcomes, moving from the Federal Reserve in the US making a quick monetary policy mistake at one end, a muddle through scenario with mild recession risk, a stagflation scenario, and a soft landing at the other end.
Hennessy felt the most likely scenario, in his opinion, would be for a period of higher-for-longer cash rates that could lead to a recession. This was the second option, the muddle through scenario, where inflation falls but still remains above central bank targets.
Interest rates in Australia have risen to 4.1 per cent, but the Reserve Bank of Australia opted to pause at July’s meeting to allow the impact of previous rate rises to be factored in. The RBA’s inflation target is 2–3 per cent.
“In this scenario, bond yields at least provide yield and recession diversification. Investors need to be selective within equities, underweighting those priced for soft landing while seeking to overweight those assets and sectors already factoring in pessimistic outcomes,” said Hennessy.
In the event that Fed made a policy mistake, this will cause credit conditions to tighten, inflation to fall sharply, and bond yields to be less than 3 per cent. The federal fund rate in the US is currently at 5.25 per cent, but the Fed is expected to be the first central bank to start cutting them next year.
There are no expectations for a cut by any central bank to take place this year.
Hennessy said the broad range of possible options means it is more important than ever for investors to have a diversified portfolio.
“Bonds have a place in portfolios, perhaps more so than they have in quite a few years now. Yields are in the 3–4 per cent range — not exciting, but they provide a bit of protection to investors for those more pessimistic scenarios,” Hennessy said.
“Cash and other short-dated investments that provide returns in that 4–5 per cent range can also provide a bit of flexibility for investors.
“The range of outcomes is so wide and broad, investors need to respect the uncertainty that currently exists.”
AUTHOR
Laura Dew
Recommended for you
With Q1 of the 2025 calendar year coming to a close, the Australian funds management industry has seen a range of major appointments and departures.
Nearly half of wealth managers across the globe say offering access to private market funds is integral to their growth plans, Natixis Investment Managers has uncovered.
Boutique fund manager and responsible investment specialist Pella Funds Management has expanded its offering by allowing direct access to investors in New Zealand for the first time.
The global alternative asset manager has welcomed an experienced distribution lead to its leadership team.
