The current steady but unspectacular global growth backdrop has not materially changed. We remain optimistic that global growth of around 3% is sustainable while recognizing that high debt loads and other headwinds, including low productivity and...
aging populations, continue to flash a cautionary sign in many economies. Global inflation appears to have stopped declining as the extraordinary monetary policy effort seen in developed nations finally seems to be bearing fruit. Our view, however, remains that this will be a very slow process, taking many years and continuing to require meaningful monetary and even fiscal support. This view suggests that spread sectors will continue to be preferable to holding developed market government bonds. It also suggests, however, that any meaningful or swift increase in inflation or interest rates is not imminent.
Recent news has made us downgrade our outlook for US growth. We focus on the lack of growth in recent months in capital spending and export activity and related flattening out in US factory sector activity. We doubt these developments have yet shown up on the US Federal Reserve (Fed)’s “radar screen,” but the resulting slowing in overall growth will soon be apparent to the Fed and could lead it to be more cautious about further rate hikes. We continue to favour long US government bonds, while we are less keen on European, UK and Japanese sovereigns.
Europe and Japan
We expect the eurozone to grow at around 1.7% to 2.0% in 2017, notwithstanding the uncertainty caused by the UK’s decision to leave the European Union (EU). With deflation risks in the eurozone dissipating, however, the market’s focus has shifted to when and how the European Central Bank (ECB) will normalize its monetary policy stance. While underlying measures of core inflation remain subdued, we believe the ECB will continue to keep interest rates low and we expect asset purchases to continue into 2018. Despite the uncertain political landscape, over the longer term we believe Italy will continue with its reform agenda and that valuations remain attractive versus German bonds.
In Japan, we expect growth to improve to around 1% to 1.5% in the context of the current fiscal and monetary policy mix, the delay in the consumption tax increase and the improving global economy. Inflation remains low although it should increase gradually due to a tighter labor market. We expect the Bank of Japan (BoJ) to continue with its accommodative monetary policy for some time to meet its inflation goal. With 10-year nominal yields capped around 0% by the BoJ, we expect real yields to decline further and maintain exposure to Japanese inflation-linked bonds. We still expect the yen to continue its weakening trend versus the US dollar.
Our base case view for credit spreads remains a modestly tighter destination in the near-to-midterm, but the aggressive move tighter in spreads over the past several months has valuations nearing what can only be described as fair. We remain vigilant about global risks which may impact credit markets, such as a sharp deceleration in Chinese growth. The technical tailwind remains favorable as demand remains firm despite the decline in spreads. Supply trends, after many years of increases, are expected to decelerate in the second half of the year. We remain cautious about the potential for further Merger & Acquisition activity and shareholder-friendly activities in certain industrial sectors such as healthcare/pharmaceuticals and telecommunications. The largest sector bias remains in the financial sector, where deleveraging, capital build and regulatory constraint remain credit-positive.
We continue to be constructive on emerging market (EM) debt and believe there is room for further spread compression versus developed markets.
We favour spread sectors, in particular to investment-grade corporate bonds and select EM US dollar- and local-currency-denominated bonds, to take advantage of attractive valuations. We continue to look for opportunities to benefit from market anomalies. Our focus remains on longer-term fundamentals with diversified strategies to manage risk.