Trimming our overweight to bonds: Federal Reserve delivers a Christmas gift to jubilant markets

19 Dec 2023

In this Special report, we take the opportunity to trim our government bond overweight modestly, locking in some profits, given the historic move in bond markets since late October. At the same time, we have added back to short maturity fixed income. This portfolio trimming move maintains our high conviction overweight to fixed income relative to cash and we continue to favour government bonds and investment grade credit over floating rate income. We remain neutral on equities and underweight cash.

Over the past few months, we have seen firming signs that the global economy is slowing but not stalling, with inflation decelerating over the same time frame. This evolution in the macro backdrop has allowed most major central banks to more clearly signal that the peak of rates is in, with markets increasingly confident that the next move in rates will be lower. This has supported a significant compression in global bond yields from their mid-October highs, alongside a rally in global equity markets. Our outlook for 2024 remains unchanged, with growth, inflation, and interest rates likely to be lower over the year ahead. However, we believe that it is prudent to lock in some of this outperformance now, given the scale of recent market moves.

Much progress has been made on growth and inflation, encouraging central banks to adopt a more dovish stance heading into Christmas.

Central banks have been encouraged by recent progress on growth and inflation

A lot can happen in six weeks. When we last changed our tactical asset allocation (TAA) by increasing our overweight to government bonds in early November, US 10-year Treasury and Australian 10-year Commonwealth Government bonds were yielding about 4.9%. At the time, we believed that these were highly attractive levels of yields that presented a very favourable risk-return trade-off for investors. 

Over the past six weeks, the yields on these instruments have compressed significantly, to 3.9% and 4.1% respectively as of 18 December. This has been driven by a combination of several factors:

  • Economic data has moderated. Higher frequency indicators are pointing to slowing growth and moderating labour market conditions, as the lagged impacts of prior monetary policy tightening continues to work its way through the global economy. Importantly, there have been no signs, as yet, of significant economic weakness that might augur an imminent recession.
  • Inflation has slowed sharply. Encouragingly, there has been strong recent progress on bringing inflation down. While year-on-year measures of inflation are still broadly above central bank targets, inflation is now clearly annualising at a materially lower rate. In the US, the Federal Reserve’s (Fed) preferred core inflation measure (the Personal Consumption Expenditure Price Index) has moderated from an annual pace of around 4.5% in H1 2023 to a little less than 2.5% in the most recent three months. Similarly, after Australia’s higher-than-expected rise in inflation in Q3, monthly data showed some improvement to 4.9% in October (having unexpectedly risen to 5.6% in September), down from 8.4% at the end of 2022.
  • Central banks have more clearly indicated they are done. The encouraging developments on both growth and inflation have given central banks (except in Australia) greater confidence that they have ‘done enough’ tightening, with the Fed signalling at its December meeting that it expected to cut rates three times next year, while Fed Chair Powell did not push back strongly against market pricing for even more.

Markets have responded powerfully to the macro backdrop and policy signalling. There has been an historic compression in bond yields, as our six-month outlook played out over the course of six weeks.

The path ahead still points to lower rates in 2024, but extreme market moves present a pre-Christmas opportunity to right-size our tactical positioning

This evolution in the macro backdrop and policy outlook has been broadly in line with our central case outlook that we published in our December Core Offerings. This means that things have been playing out in line with our expectations. However, the speed, magnitude, and volatility of market moves over the past six weeks have been historic.

  • The six-week decline in US 10-year Treasury yields since early November is the largest since the COVID-19 pandemic in 2020 and the 2011 European sovereign debt crisis. 
  • The single-day decline in US 2-year Treasury yields immediately after the Fed’s December meeting was the largest since the collapse of Silicon Valley Bank in March and the 2008 GFC before that.
  • A measure of the volatility of bonds relative to equities (the ratio of the MOVE index to the VIX index) is at its highest level since 1994, indicating that bond markets are experiencing extreme levels of volatility relative to equities.

We maintain our view that the path ahead still points to lower growth, lower inflation, and lower rates in 2024. However, as a result of these extreme market moves, we believe it is prudent to slightly trim our government bond overweight to reflect the shifts in market pricing.

We have taken advantage of the extreme market moves to trim our government bond overweight, while maintaining our high conviction overweight to fixed income.

What changes have we made?

Being cognisant of reduced liquidity and light market participation in the week before Christmas, we are only making a single change to our TAA positioning.

We have trimmed our government bond overweight, but maintain a high conviction overweight to fixed income. We are reducing our high conviction +3 overweight in government bonds to a still strong +2 overweight, while adding back to short maturity fixed income. Within this, we favour trimming global government bonds and maintaining a relative overweight to Australian government bonds, given a more disciplined Australian fiscal outlook compared to global peers at this point in the cycle.

We maintain our underweight to cash. With central banks more likely to cut than hike next, we continue to believe that fixed income provides a better risk-return trade-off compared to cash.

We maintain our neutral view on equities. We remain comfortable with our equity tilts, and continue to think that an opportunity to take a more positive view on equities may emerge as 2024 progresses, depending on the extent to which the earnings outlook changes over H1 2024. 

Previous tactical asset allocations (% weights)
New tactical asset allocations (% weights)


This document has been prepared by LGT Crestone Wealth Management Limited (ABN 50 005 311 937, AFS Licence No. 231127) (LGT Crestone Wealth Management). The information contained in this document is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence a person in making a decision in relation to any financial product. To the extent that advice is provided in this document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of a financial product, you should obtain and consider a Product Disclosure Statement (PDS) or other disclosure document relating to the financial product before making any decision about whether to acquire it.

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