We expect solid US economic growth to continue, and we believe inflation is likely to remain low for the next several months before moving higher in 2018. This does not affect our forecast for the US Federal Reserve (Fed) to begin tapering its reinvestment program in September. However, inflation data will be critical in determining when the Fed raises the federal funds rate again. If inflation stays low, this may not occur until mid-2018. In our view, global monetary policy will continue to be the main driver of long-term US rates, with tighter European Central Bank (ECB) policy and a rising global term premium likely to push them higher by the end of this year.
Economic growth in the eurozone has continued to improve. The rebound in growth and the modest bump in inflation (still below the ECB target) have elicited some less dovish rhetoric from ECB Governing Council members. We now expect the ECB to taper its quantitative easing program further in January 2018, lowering bond purchases to €40 billion a month. The ECB may increase interest rates at some point during the next 12 months but the probability of such a move has fallen in recent weeks, as the euro has continued to appreciate and inflation slipped to 1.3% in June from 1.4% in May and 1.9% in April. 1
The onshore Chinese government bond yield curve bull steepened as short-term rates fell faster than long-term rates in the first half of July. Short-term rates dropped thanks to abundant liquidity, while long-term rates were relatively stable. Risk appetite is expected to fall sharply following the government’s strong remarks in the National Financial Work Conference, which is positive for government bonds in the medium term. In the near term, strengthening financial regulation and deleveraging efforts together with tax payments are likely to create short-term volatility in liquidity conditions. Post-conference, we expect government bonds to outperform in the second half of 2017 while credit spreads, especially for lower credit quality issuers, likely have room to widen.
The Japanese economy continues to grow in excess of its potential, with leading indicators suggesting that this recent trend will likely continue. Prime Minister Abe’s approval rating has deteriorated somewhat of late as he has become associated with a number of domestic scandals. However, we believe that the prime minister will switch his focus from his personal agenda preferences (such as constitutional reform) to growth-enhancing measures going forward. If he does, voter support should rebound. Japanese government bond yields continue to trade in a very tight range of 0% to 0.1%, and we expect that range to hold.2 The Bank of Japan will likely maintain current policy but continue to reduce the monthly rate of asset purchases as long as conditions permit.
Consumers could struggle to contribute to UK growth over the coming years. Against a backdrop of rising home prices, rising real wages and low inflation, consumers have been happy to spend down savings or take on increased levels of credit card debt. However, the good times could be coming to an end. Savings are now at all-time lows, real wage adjustments have turned negative, banks are tightening lending criteria and the housing market is slowing. Any pickup in exports (resulting from a weaker pound) or less focus within the new minority government on austerity would be unlikely to make up for such a shortfall. Business investment is also likely to remain subdued while the UK’s ongoing relationship with the European Union (EU) remains unclear. Longer term, we expect that the UK will eventually agree to a softer Brexit or eventually opt to remain in the EU. While this drama plays out, we favor remaining underweight gilts relative to US Treasuries. We expect the Bank of England to keep policy on hold through 2018.
After hitting lows for the year in June, 10-year government bond yields rose to a two-year high of 1.89% in July,3 as the Bank of Canada (BOC) unsurprisingly increased its benchmark rate by 0.25% to 0.75%.4 The accompanying statement was upbeat as well, brushing off softer inflation numbers as temporary. The BOC’s optimism will probably keep the possibility of another rate hike alive at each of its upcoming meetings. We expect interest rates in Canada to rise from current levels, but we are looking for signs that rates may have topped out in the short term.
The Reserve Bank of Australia (RBA) held its benchmark interest rate steady at 1.50% as expected in July.5 The RBA’s statement was unexpectedly neutral in tone, giving no hint of a rate hike anytime soon. The RBA continues to be concerned with the leverage-driven housing market. This will likely keep the RBA from lowering interest rates while stubbornly low inflation (especially in wages) may keep it from raising rates. While there have been a few signs of economic improvement, the Bank will likely be on hold for the foreseeable future. As such, we remain neutral on Australian interest rates.
Rob Waldner, Chief Strategist; James Ong, Senior Macro Strategist; Sean Connery, Portfolio Manager; Brian Schneider, Head of North American Rates; Scott Case, Portfolio Manager; Josef Portelli, Portfolio Manager; Yi Hu, Senior Credit Analyst; Ken Hu, CIO Asia Pacific; and Alex Schwiersch, Portfolio Manager
1. Eurostat, data as of June 30, 2017
2. Bloomberg L.P. as of June 19, 2017
3. Bloomberg L.P., July 19, 2017
4. Bank of Canada, July 12, 2017
5. Reserve Bank of Australia, July 4, 2017
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The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Robert B. Waldner, Jr., CFA
Chief Strategist and Head of Multi-Sector
Rob Waldner is Chief Strategist and Head of Multi-Sector for Invesco Fixed Income (IFI). Mr. Waldner has overall management responsibility for the IFI public credit asset class teams and the Multi-Sector team. In this role, he is responsible for oversight of the portfolio construction process for IFI’s public security portfolios. Mr. Waldner chairs the IFI Investment Strategy team and is responsible for oversight of the overall IFI investment process. He joined Invesco in 2013.
Prior to joining Invesco, Mr. Waldner worked with Franklin Templeton for 17 years. At Franklin Templeton, he was a senior strategist and senior portfolio manager. He was the lead manager for Franklin absolute return strategies, and a member of the Fixed Income Policy Committee. Mr. Waldner was instrumental in the launch of a number of new strategies on the Franklin Templeton fixed income platform. Previously, Mr. Waldner was a member of the Macro team at Omega Advisors and a portfolio manager with Glaxo (Bermuda) Ltd. He entered the industry in 1986.
Mr. Waldner earned a BSE degree in civil engineering from Princeton University, graduating magna cum laude in 1986. He is a CFA charterholder.