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Fixed income: market drivers, risks and views

No longer “Goldilocks” but still a positive story.

 

Thomas Sartain - Paris/Vienna

 

In 2017, economic conditions reached an optimal point, with a scenario often described as “Goldilocks” where everything was “just right”. This year, global growth remains on track and inflation pressures are benign, but risks are rising and we expect 2017 returns will not be repeated.

By Thomas Sartain, Senior Portfolio Manager

Going into 2017, growth expectations were around 1.2% and we ended up with growth rates of 2.5% to around 5%. 2017 was clearly an unexpected year, with strong growth globally above trend, moderate inflation and supportive financial conditions. And it wasn’t just about generally strong growth, it was more the fact that we didn’t have any weak spots. Are we facing similar unexpected developments for 2018/2019?

“We don‘t buy into the pessimism around growth slowdown.”

Environment remains positive

We are confident a positive economic environment will continue through 2018 into next year, supported by the fact that we have a very positive tax environment in the US. We believe the second half of 2018 will continue with strong consumer activity and corporate behavior. We don’t buy into the pessimism around growth slowdown in the second half of 2018; for example, we do not see signs of slowdown in the US, Japan is continuing to accelerate, and the risk of a hard landing in China remains very low. This leaves us in a relatively rosy spot (see chart 1): Not as positive as 2017, but we still forecast strong growth above trend, and we don’t see high inflation anywhere globally.

Our view is that financial conditions will continue to remain supportive on a global level.

Growth and inflation in the sweet spot

Growth and inflation in the sweet spot

Source: Invesco. As of May 2018. GDP = gross domestic product, CPI = consumer price index.

Inflation pressure overestimated?

Our view is that financial conditions will continue to remain supportive on a global level and inflation will remain benign. We know that inflation in the US in the next couple of months is likely to climb up to 2.7%, but in Europe, we expect inflation to eventually land below target. We do not see any evidence from bottom up analysis that inflation pressures are starting to build. The labor market conditions are not really feeding through into wage pressures at the aggregate level. That leaves us to conclude that we will not see meaningful upside inflation pressure in the next 12 to 18 months. As a result of benign inflation we believe financial conditions will remain loose, despite the shift that is clearly happening from the major central banks. There will clearly be some normalization, but we expect central banks to be very cautious.

Risks beyond inflation?

If inflation is not the danger, are there other factors that may threaten this stable growth scenario? We think there are several risks investors should monitor. Markets may be underestimating the potential for FED rate hikes in 2019. We currently anticipate two to three rate hikes during 2018, and looking ahead, we think there is more to come. Global central banks’ balance sheet expansion fueled a multi-year rally in global risk assets. Now this balance sheet expansion is slowing down (see chart 2), which may lead to higher rates.
Other risks to consider are oil price spikes and dollar rallies, and as always, there are obviously political risks, among them the danger of a global trade war.


“Markets may be underestimating the potential for FED rate hikes in 2019.”

Potentially higher rates?

Potentially higher rates?

Forecasts are based on current market conditions and are subject to change without notice.

Positive outlook – but caution is warranted

To summarize, we believe global growth will remain on track despite first quarter slowdown in Europe. We expect the US economy to continue to grow above trend, and Europe to stay within growth expectations. Inflation pressures are benign and are unlikely to move significantly higher. The US dollar should underperform risk currencies, and the duration should remain range-bound. At the same time, we believe financial conditions will remain loose globally, despite the FED hiking rates, and volatility spikes will be more frequent.

Having said this, it should be added here that there are risings risks for this positive scenario, and 2017 returns will not be repeated. Security selection and offsets are key for investors – and caution is warranted.

Risk warnings

The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.

Important information

This webpage is exclusively for use by Professional Clients and Financial Advisers in Continental Europe (as defined below) and Qualified Investors in Switzerland. This webpage is not for consumer use, please do not redistribute. Data as at 31.05.2018, unless otherwise stated. This website is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities. By accepting this website, you consent to communicate with us in English, unless you inform us otherwise. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.

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