U.S. Interest Rates Expected to Fall, Investors Remain Bullish Amid Geopolitical Risks

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Investor sentiment remains positive due to expectations of a decline in U.S. interest rates, which is anticipated to prevent a severe economic downturn. However, geopolitical issues are emerging as the most significant threat to this outlook, according to the latest global fund manager survey by Bank of America (BofA), released on Tuesday.

The survey, conducted from July 5-11, gathered insights from 242 fund managers overseeing assets worth $632 billion. It is important to note that the survey was completed before the assassination attempt on U.S. presidential candidate Donald Trump during a political rally over the weekend.

A notable decline in global growth expectations was observed, marking the steepest month-on-month drop since March 2022. The survey revealed that the metric fell sharply to -27% from -6%, largely due to an increasing number of respondents foreseeing a weaker U.S. economy. This shift reflects the belief that interest rates are poised to decrease, as current monetary policy is perceived as overly restrictive, reminiscent of conditions during the 2008 financial crisis.

According to the survey’s authors, led by investment strategist Michael Hartnett, “Monetary policy is too restrictive according to 39% of investors, the most restrictive since November 2008. However, this in turn deepens the belief that global interest rates are set to fall over the next 12 months.”

A significant majority of those surveyed, about 68%, predict a “soft landing” for the global economy, where both growth and inflation gradually ease. The BofA team elaborated, “We believe ‘hard landing’ risks are underpriced, given the slowdown of U.S. consumer spending, labor market activity, and government expenditure. This makes us most bullish on bonds and gold in the second half of 2024.”

Political developments in the U.S. and globally have increasingly influenced market dynamics over the past month. In France, a snap election resulted in a hung parliament, while in the U.S., President Joe Biden faced mounting pressure to step down as the Democratic candidate following a televised debate with Trump that raised concerns about his capacity to serve another term if re-elected in November. Meanwhile, geopolitical tensions persist, with Russia’s invasion of Ukraine continuing into its second year, escalating conflict in Gaza, and rising friction between China and Taiwan.

For the first time in six months, the survey identified “geopolitical conflict” as the top tail risk for the investment outlook, surpassing concerns about “higher inflation.” Despite these risks, investor positions have remained overweight in stocks and underweight in bonds. The survey also noted the most significant reduction in exposure to European Union equities in two years.

Fund managers have adopted their largest underweight position in real estate investment trusts (REITs) since January 2009. Conversely, there has been a notable increase in overweight positions in utilities, which typically underperform when interest rates are high, marking the first such increase since February 2009.

Furthermore, ownership of the “Magnificent Seven” group of the seven most valuable U.S. stocks—including Apple, Microsoft, and Nvidia—was identified as the most crowded trade “by a country mile,” according to BofA.

Overall, while investors remain optimistic about a potential easing of U.S. interest rates and the possibility of avoiding a hard economic landing, the growing influence of geopolitical factors presents significant risks that need to be closely monitored.