Fixed Income Perspectives - Fixed Income Themes Update
Twice a year we refresh our decision framework. As the second half of 2017 gets underway, here's how we view fixed income investing.
Our semi-annual themes provide a framework for our investment decisions. Our holistic view of the economy and global monetary policy helps determine the overall risk budget and portfolio positioning to capitalize on relative value across sectors, while helping inform our bottom-up security selection process. As the second half of 2017 gets underway, here is how we are seeing the investment landscape.
Investment Themes1. U.S. Economic Growth: Near-term growth in the United States will be closely tethered to trend level. The benefit from demand-oriented policy (tax cuts) is likely to be limited and short-lived. Supply-oriented policies, such as significant deregulation or true tax reform, are unlikely but would have more lasting benefits on growth.
2. Wages and Inflation: Wage pressure within the U.S. economy will continue to increase, albeit unevenly across industries. Overall inflation pressure will be limited by global excess supply. Wage increases for lower income workers will help offset current spending constraints and improve debt service capacity.
3. Fed Policy Outlook: Balance sheet reduction will be the near-term focus of the Federal Reserve; a cautious pace of rate normalization guided by market expectations will continue later. Continued easy monetary policy will keep volatility uncomfortably low, supporting full but sustainable valuations of risk assets.
4. Europe: Growth within Europe will continue at an above trend pace, as declining political volatility allows more cooperation within the European Union. The European Central Bank will stop expanding its balance sheet later this year, but with no pressure from inflation will be patient to raise rates.
5. China: Policy-makers will continue to manage growth within a narrow band as the country transitions from an “old economy” industrial base to a more consumer-oriented economy and implements financial system reforms. In the near term, China’s high potential growth rate will allow the central government sufficient policy tools to address any resulting instability.
6. Emerging Markets: Growth within EM will remain robust, supported by a contained U.S. dollar, low global interest rates and sustained developed market growth. Risks within EM are primarily idiosyncratic, except for largely priced-in systematic risks from China and the associated effects on commodity prices.
7. Credit Markets: With limited overall input cost pressure, corporate profit margins will be resilient. The combination of improving credit fundamentals and continued easy monetary policy will push credit spreads to new post-crisis tights even as we move closer to the end of the current cycle.