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By John Lovito - July 5, 2019
A lot has changed in the first half of this year. In 2018, the Federal Reserve (Fed) was committed to raising rates and things were looking up for the U.S. economy. But now, it's a much different story.
The Fed may begin to ease rates, potentially as soon as July. We’re seeing a slowdown in global growth, particularly in Europe and China, and optimism for the U.S. has been tempered by trade tensions with China. Even if this uncertainty is already factored into the markets, growth prospects will likely be less robust than they would have if we didn’t have a trade conflict.
So what does this mean for bonds? We don’t expect a global recession, but from a risk perspective, we want to remain cautious in our portfolios. Click on my video below for more insight on how we’re positioning our fixed income assets.
I think if you look at the global landscape over the next 6 to 12 months, I think it's one of uncertainty. What will U.S. growth look like post the China-U.S. trade conflict? Will European growth stabilize? What does China growth look like over the next six to twelve months as well will be another issue.
A lot has changed here in 2019. if you remember, the theme of 2018 was higher rates with regard to the Federal Reserve (Fed) lifting rates as we saw a stronger economy. Inflation wasn't really that much higher, but still a little bit higher than we had seen in the past, and things were looking fairly optimistic for the U.S. economy.
As we've entered here in 2019, it's a much different story. Rates have rallied quite a bit. The talk now with the Federal Reserve will begin to ease rates, potentially as soon as July. And it really comes on the heels of a few things.
One is the global economy has slowed fairly dramatically over the last year. Europe, which was growing north of 2, 2.5% at one point in early 2018, is now closer to 1%. China has continued to decelerate over the last six months to a year as well. While U.S. growth looks fairly robust still, it does seem to be slowing more recently, as we've had more tension with regard to the U.S.-China trade conflict.
If we have a resolution, and it's a resolution that will stick, clearly it's better for the global economy—it's better for global trade. However, the question is, how much damage has been done between the start of the crisis and now?
If you think about it from a business perspective, you really don't know what to expect going forward with regard to uncertainty, and that has to be baked in the cake to some extent right now. Which means that companies will be a little bit more reluctant to invest, to be more longer-term thinking with regard to sort of more uncertain policy. So, no matter what, growth prospects going forward are probably a little bit less robust than they would've been if we didn't have the trade conflict to start with.
So, with regard to bright spots, while we don't expect a global recession, we just think it's time to sort of take it a little bit easy and wait for a better time to add risks going forward. We are really just playing it more cautious right now and just waiting it out a little bit.
It's a good time to do that because if you look at overall valuation, it's not as if we're cheap. Even though we've had more volatility, we're still on the richer end with regard to risk assets, whether it's investment grade, whether it's high yield. Emerging markets are a little bit more fair value. But that said, we believe that there is a better opportunity to offer value down the road when we see spreads widen out.
Right now, from a risk perspective, we're a little bit more cautious in general. We talked about the trade situation, we talked about U.S. growth while fairly good—maybe slowing a little bit—and we talked about Europe and China. So, we are more cautious with regard to our overall risk profile, and we've done a few things to alter our portfolios just for that reason.
We've reduced risk. If you go back to the end of last year, we increased risk with the trade, with the sell-off in Q4. We increased, for instance, high-yield exposure to around 14%. But if you look at where we are now in our global portfolios, we're close to 0%, again, for those concerns that we have with regard to the potential volatility going forward.
There is a certain feeling that, given the uncertainty, the Fed is going to have to react to make sure that financial markets remain calm. With that said, there's uncertainty in terms of what's going to happen going forward. The big question mark in the short run is, will there be a resolution to the U.S.-China trade conflict? If there is, the Fed may not need to be quite as aggressive going forward as what the market's pricing in.
Get additional fixed income market insights and more in our latest Investment Outlook.
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