Central bank support for financial markets has been one of the defining characteristics of the post-crisis environment. In Europe and Japan, this approach has driven the European Central Bank (ECB) and Bank of Japan (BoJ) to extreme lengths. As we discussed in Macro Insights: A Turning Point in Policy, markets are now questioning the sustainability of this approach and the implications for a market regime that has been very supportive for fixed income markets. In this Global Fixed Income Outlook, we discuss our views on the potential for an inflection point and fixed income strategy.
- In the short term, we think global growth remains modestly positive. The US labor market remains strong, China and Japan are benefitting from fiscal stimulus and the effects from the UK’s vote to exit the European Union (“Brexit”) have so far been relatively modest.
- Over the long term, we are more cautious about the outlook. Central bank policy may be encouraging excessive risk-taking, rising wealth inequality is contributing to political risk and fiscal stimulus adds as much to debt growth as it does to economic growth.
- We currently see no clear catalyst for an inflection point in markets. Our longer-term risk scenarios primarily focus on growing imbalances in China, Japan and Europe. However, when we look at the current outlook for these economies, we see no clear catalyst that is likely to change the market regime that has favored fixed income assets.
- Political risk is likely to be the main source of volatility. Over the next 12 months, the US, France and Germany will all hold elections. Italy will hold a constitutional referendum with implications for its current government. We think markets are likely to take the US election in stride as long as neither party wins complete control, but the European political backdrop may hold bigger implications.
- We think the goal of fixed income investing in today’s environment is to navigate the differences in the short- and long-term outlooks. In our view, the relatively positive short-term outlook favors maintaining exposure to higher-yielding sectors of the fixed income market. However, given the long-term risks, we prefer strategies that combine long and short exposures with the goal of preserving yield and upside potential while hedging against the risk of systemic changes in spreads or interest rates.