We remain optimistically cautions that the Fed will see the light, that Brexit will move in a benign fashion, and that tariff disputes will subside. Spread sectors and duration remain our focus.
“It’s déjà vu all over again.”
— attributed to Yogi Berra
- Global growth has improved from the worst-case fears of late 2018 and monetary policymakers have declared explicitly that their goal is to extend the expansion.
- With the annual US growth rate slipping below 2% and inflation falling further, we believe the Fed will begin to discuss whether a policy cut is needed.
- While risks of a “hard Brexit” have increased with the departure of UK Prime Minister Theresa May, we continue to believe a deal will be reached.
- We expect global growth to remain sturdy, and for interest rates in the US to remain attractive compared with the rates of other developed market countries.
- The global backdrop of low inflation, low interest rates and accommodative monetary policy underscores our resolve to stay the course with overweight spread products and a long duration complement.
Exhibit 1: YTD 2019 Excess Returns
The Fed needs to move to a more dovish stance, trade tensions need to lessen and worst-case fears over Brexit need to recede.
We have been cautiously optimistic on Chinese growth, understanding the sustained monetary and fiscal stimuli that have been at work would slowly but surely gain traction. Indeed, the economic indicators have been signaling not just economic stabilization but improvement as well. Our view that the second half of 2019 would prove better than the first appeared to be coming home. Now the reignition of trade tensions has put that improvement at risk. Our expectation had been that there would be a trade deal, bringing down the temperature of US-China tensions. But we understand completely that the economic competition between these powers will be ongoing. We still hold out hope that a deal may yet be completed. But even if it is not, we expect Chinese growth, while weaker than otherwise, to remain sturdy. The need to successfully compete economically with the US in the face of escalating trade disputes will demand yet more stimulus, and we believe it will be forthcoming.
Trend growth in Europe is reckoned to be only in the neighborhood of 1.0% to 1.25% annually, so the bar for growth is low. Despite gathering political clouds, the economic backdrop for European growth had been quietly but steadily improving (Exhibit 2). Our view has been that such modest levels would be achieved absent a political shock, particularly Brexit. As Americans, the good news about Brexit is that however dysfunctional our politics seem, the British have managed to outdo us. With Prime Minister Theresa May’s departure, the risks of a “hard Brexit” have increased. Our base case, though, remains that a mutually palatable deal will be reached. This will take time, and weigh on business and investment sentiment.
As Americans, the good news about Brexit is that however dysfunctional our politics may seem, the British have managed to outdo us.
Exhibit 2: After Evidence of Weaker European Growth Earlier This Year, the Overall Outlook Is Now Improving
Our thesis is that global growth will remain sturdy. This seemingly low bar for global growth is now being challenged, but we think optimism on this point remains warranted. The fledgling improvement we had been seeing in global economic data two weeks ago may become less pronounced, but we believe it is unlikely to be reversed. Furthermore, policy accommodation may be forthcoming to undergird the expansion, particularly from China and the US. Last, there is the very real prospect of positive surprises. Two weeks ago, market optimism of an impending trade deal was rampant. This has been replaced by extreme pessimism that a deal can be reached. Optimism that a “hard Brexit” was completely off the table abounded; now fear has taken its place. If these uncertainties are lifted, investors who exited spread positions will be hard pressed to reclaim positions.
Our thesis is that global growth will remain sturdy. This seemingly low bar for global growth is now being challenged, but we think optimism on this point remains warranted.
Spread sectors refers to sectors of the bond market, such as taxable bonds that are not Treasury securities, and includes securities such as agency securities, asset-backed securities, corporate bonds, high-yield bonds and mortgage-backed securities.
Excess return refers to return above that of the index or often in the case of bonds it refers to the return of a non-Treasury security above that of a comparable maturity Treasury.
The S&P LSTA Performing Loan Index tracks the current outstanding balance and spread over LIBOR for fully funded term loans. The facilities included represent a broad cross section of performing leveraged loans syndicated in the U.S., including dollar-denominated loans to overseas issuers. The London Interbank Offered Rate (LIBOR) is the interest rate determined daily by a specific group of London banks for deposits of certain stated maturities.
The Federal Reserve Board (“Fed”) is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The Federal Reserve’s dot plot shows the projections of the 12 members of the Federal Open Market Committee (FOMC) on where they think fed funds rate should be at the end of the various calendar years shown, as well as in the long run—the peak for the fed funds rate after the Fed has finished tightening or “normalizing” policy from its current levels. The dot plot is published after each Fed meeting.
The Personal Consumption Expenditures (PCE) Price Index is a measure of price changes in consumer goods and services; the measure includes data pertaining to durables, non-durables and services.. Core PCE excludes food & energy prices.
U.S. Treasury inflation protected securities (TIPS) are a special type of Treasury note or bond that offers protection from inflation. Like other Treasuries, an inflation-indexed security pays interest six months and pays the principal when the security matures. Also referred to as “Treasury inflation-indexed securities.”
The Barclays Capital Global Aggregate Index is an unmanaged index used as a broad measure of the global bond market.
The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news defined as weighted historical standard deviations of data surprisesA positive reading of the Economic Surprise Index suggests that economic releases have on balance been beating consensus.
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