What's Ahead for Growth and Rates

Q1 Market Outlook

What's Ahead for Growth and Rates

The Fed's willingness to ease if inflation disappoints — even if growth remains above trend — now appears stronger.

Key Takeaways

  • Global growth optimism—which had been picking up steam on the back of positive developments around both Brexit and the US-China trade conflict—has been severely dampened by the impact of the coronavirus outbreak.
  • Emerging Market (EM) valuations have been significantly battered across the board, while DM equities have remained remarkably resilient.
  • Even considering the obstacles, we believe global growth rates will continue to improve.
  • We’ve revised our outlook for the possibility of central bank easing, thinking the Fed’s continued emphasis on below-target inflation may make further cuts more likely.
  • Given the precipitous drop in valuations that belie the underlying positive fundamentals, we continue to believe that EM is the most attractive sector in fixed-income.
“If you do not change direction, you may end up where you are heading.”
Lao Tzu

The global economy just doesn’t seem able to catch a break. Right as trade tensions and Brexit uncertainty declined, the coronavirus and the challenging efforts to contain it threaten to derail or at least postpone any pick-up in the global recovery. This has been challenging for market participants as the early economic data this year suggested the possibility that the recovery was improving. Markets quickly repriced to a more positive global outlook, even without decisive evidence that the global manufacturing weakness was ending. With China’s growth rate now being revised sharply lower in the first quarter and thereby meaningfully lower for the full year, the diminished global growth outlook has caught investors offside. US Treasury and developed government bond markets around the world have rallied sharply. Emerging market (EM) currencies, stocks and bonds have been pummeled. Devel­oped market (DM) equities have held up surprisingly well, buoyed by even lower interest rates and perhaps the prospect of further central bank stimulus.

Even if the global recovery has been merely retarded rather than derailed, the weaker outlook and shallower recovery put a particular focus on two elements of our investment strategy. The first is the prospect for EM debt, a sector we have been championing. The second is the heightened difficulty central banks will face in putting a floor under inflation and inflation expectations, an issue we have highlighted for the length of the post financial crisis recovery period.

“With China’s growth rate now being revised sharply lower in the first quarter and thereby meaningfully lower for the full year, the diminished global growth outlook has caught investors offside.”
Western Asset

We have been constructive on all three forms of EM debt: USD-denominated sovereign, USD-denominated cor­porate and local currency bonds. The most volatile segment has been local currency debt. Exhibit 1 shows the price performance of the J.P. Morgan GBI-EM Global Diversified Price Index (GBI-EM) since 2010. Note that in a period when DM spread products have done extremely well, leading to yield-spread levels that are at post-crisis tights, the GBI-EM Index is down nearly 40% from the level that prevailed earlier in the decade. It is this extremely low price that helps inform our view that EM is the most attractive sector in fixed-income. 

Exhibit 1: Higher EM Yields Combined With Weak Currency Presents Buying Opportunity

Source: J.P. Morgan, Bloomberg. As of 31 Jan 2020. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


EM local currency debt was beaten up by the 2013 taper tantrum. After a minor recovery in 2014, it was mauled by the 2015-2016 global growth fear that saw oil drop to $25 a barrel. At that time, our view was that the substantial cheapness of the sector combined with a prospective global growth improvement would usher in an extended period of outperformance. After a good start in 2017, the worst of all worlds hit in 2018. Not only did EM suffer from the taper-tantrum-like effects of higher interest rates as the Federal Reserve (Fed) tightened policy four times and the dollar rose, but concurrently EM suffered from the fears of a global slowdown as economic growth outside the US was increasingly revised downward. Then in 2019, the reasonable prospect of a bounce from diminished levels was held in check by the risk of a protracted trade war.

“Our view is that the path of global growth will not only continue to be positive—we believe ultimately that it will turn up.”
Western Asset

This year, EM has turned down again as the result of global growth caution. It is also being challenged by the renewal of the concept of US exceptionalism—that growth in the US will be persistently higher than in other DM economies. These concerns also auger for a higher dollar, creating additional currency pressure. So for those who are sticking with this position, is it simply a stubborn example of hope over experience?

As value investors, we are informed primarily by valuation. The 40% decline in EM prices stands in sharp contrast to the 10-year highs in DM fixed-income sectors. The optimism underlying DM valuations relies upon a sustained global expansion. A global downturn would cause spread-widening stress that would be hardly isolated to EM. Conversely, if the trajectory of global growth once again turns up, the potential outperformance for this sector would be substantial. In the meantime, as the global crosscurrents are being sorted out, the carry advantage of this sector is meaningful. The GBI-EM Index yields 4.77% compared with the Barclays Global Government Index yield of 0.84%.

The decline in EM inflation rates combined with the reversal of Fed policy in 2018-2019 from tightening to easing has given EM economies scope for meaningful monetary stimulus. Our view is that the path of global growth will not only continue to be positive—we believe ultimately that it will turn up.

In light of the possibility of a weaker global growth outlook, DM inflation expectations have fallen further below targets. The long-term fall in inflation breakevens and surveys of inflation expectations further underscore the deepening skepticism that trend inflation can ever be achieved.

In our last note, we highlighted and welcomed the major central banks’ efforts to directly target inflation outcomes. We felt that while the bar to raise short rates in the US was extremely high, the Fed was also unlikely to cut rates without a material shortfall in growth. Recent developments have changed our mind. Particularly instructive are the most recent quotes of Fed Chair Jerome Powell, who has more strongly articulated his determination not to let inflation expectations decline further as the Fed fights to attain its 2% inflation target.

“We have seen this dynamic play out in other economies around the world, and we are determined to avoid it here in the United States.” “... we’re not satisfied with inflation running below 2% …”
Jerome Powell, January 2020

We now think the Fed’s willingness to ease if inflation disappoints—even if like last year growth remains above trend and financial conditions remain elevated—is much stronger. New York Fed president John Williams suggested as much when he said, “But expectations depend on deeds, not just words …“

We have long maintained that the road to inflation normalization would be protracted and would demand sub­stantial policy support. Over the last 10 years, policymaker and market participant declarations that policy was unduly supportive of accelerating inflation have proved continually mistaken. Finally, the major central banks seem unified in committing to directly take on this heretofore underappreciated challenge.

From our perspective, if words continue to be followed by deeds, the prospects for putting a floor under DM inflation are actually getting better.


Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The JPMorgan Government Bond Index-Emerging Markets (GBI-EM) indices are comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging Market governments.

A spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.

“Taper tantrum” refers to the financial markets’ reactions, in May-August 2013, to the announcement by the Federal Reserve that it was planning to decrease, or “taper” its $70 bn per month bond buying program.

Carry refers to a bond market tactic where you borrow and pay interest in order to buy something else that has higher interest.

The Bloomberg Barclays Global Aggregate Government Index is a measure of investment-grade rated debt from 25 local currency markets. This multi-currency benchmark includes treasury and government-related fixed-rate bonds from both developed and emerging markets issuers.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.