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US: Neutral. We expect US rates to stay range-bound, caught between growing trade worries and above-trend US growth. Core inflation continues to be benign, and we expect it to peak in the next two months at around 2.4%. After this, we see softer rental and service costs driving it below 2%. Assuming no large trade-driven shocks, US growth is likely to remain above trend for the rest of the year. It should be supported by increased energy sector capital expenditures, strong job growth and strong consumption. We expect 2018 gross domestic product growth of around 2.8%, 1% above the long-term sustainable trend. The risk of tighter global financial conditions due to trade-related tensions and the possibility of further tariffs in the next few months may cause asset price volatility. Treasury prices may benefit if volatility picks up.
Europe: Underweight. The escalation of tensions in Turkey and European Central Bank concern over euro area bank exposure to Turkish assets have driven German bund yields lower, although European peripheral bonds suffered with Italian bonds selling off aggressively in August. Regional economic data continued to stabilize in August, and German growth exceeded expectations in the second quarter, leading to an upward revision of eurozone growth to 0.4%, quarter-over-quarter.1 We continue to believe the bond market will begin to price greater term premium into the European yield curve given the prevailing strength of the economy and current depressed valuations.
China: Neutral. We expect a flattening government bond yield curve and think short-term rates may underperform long-term rates. This view is supported by higher overnight funding costs, expectations of potential liquidity drainage by the People’s Bank of China, expectations of large-scale fiscal stimulus and higher inflation ahead. However, the upcoming inclusion of Chinese onshore bonds into major global indexes and the low correlation of this market with other markets should lead to continuous strong foreign demand for these securities, especially those issued by governments and policy banks.
Japan: Neutral. The yields of 10-year Japanese government bonds have remained around 0.1%, while the yield curve continued to steepen in August.2 This comes as markets digest the Bank of Japan’s (BOJ) July policy adjustments that increased the target for 10-year yields. However, concerns that a global upturn in yields would be triggered by the BOJ have faded. Instead, the focus has shifted to China and fears of contagion in emerging markets sparked by the turmoil in Turkey. Meanwhile, Japanese growth data exceeded forecasts at 1.9% in the second quarter, boosted by stronger consumer spending and capital expenditures.3 Exports data, however, remained on the weak side, suggesting that growth momentum might slow over the next quarter.
UK: Neutral. Prime Minister Theresa May’s cabinet is struggling to adopt collective responsibility for the Brexit negotiating strategy drafted at the beginning of July. With only a few months until the departure date, we are no closer to understanding the UK’s post-Brexit trade relationship with the EU. Multiple outcomes are still in play: a vote of no confidence in Theresa May, another general election, a second referendum, a deferred departure date, a hard Brexit or the possibility that the UK remains a member of the EU. Tensions may heighten when UK politicians return from summer vacation in September. Our base case remains that the UK will opt for a soft Brexit, but a resolution is unlikely to be achieved until the last minute.
Canada: Overweight. Economic data remain upbeat and should support a policy rate hike by the Bank of Canada at its October meeting. The surge in July headline inflation to 3% was largely ignored by the interest rates market, as Canadian 10-year yields remain near the middle of the 2% to 2.5% range seen this year. 4,5 Growth remains on track to be above 2.0% in 2018, and the slowdown in the housing market has been offset by strong business investment and a pickup in exports. NAFTA negotiations are ongoing and are the primary cause of market uncertainty. Interest rates should be pressured lower from current levels due to overextended consumer balance sheets.
Australia: Neutral. The Reserve Bank of Australia (RBA) kept its policy rate stable at its August meeting and released an upbeat statement, shrugging off the cooling housing market. The RBA continues to believe that inflation will increase and return to its target level, but at a gradual pace. The latest employment report was mixed; the number of employed persons fell slightly, but the unemployment rate improved, falling to 5.3% (its lowest level since 2012).6 The sluggish tightening of the labor market is putting no upward pressure on wages, contributing to low interest rates and inflation. The RBA will likely leave its policy rate unchanged for some time.
India: Neutral. We expect Indian yields to stay range-bound, as has been the case for the past few months. Going forward, we believe macroeconomic risks are evenly balanced. In our view, favorable growth numbers and a downside surprise in inflation in the coming months could put downward pressure on yields, while broad emerging market sell-offs, higher oil prices and concerns about the current account deficit could have the opposite effect. Additionally, we see the Reserve Bank of India keeping its policy rate unchanged after two increases in the benchmark rate this year. It may, however, continue to engage in occasional open market operations, like those seen in recent months. This should help curb any significant sell-off in rates.
1 Source: Eurostat, Aug. 14, 2018.
2 Source: Bloomberg L.P., Aug. 1, 2018 to Aug. 24, 2018.
3 Source: National Accounts of Japan, Aug. 10, 2018.
4 Source: Statistics Canada, Aug. 17, 2018.
5 Source: Bloomberg L.P., Jan. 1, 2018 to Aug. 24, 2018.
6 Source: Labour Force, Australia, Aug. 16, 2018.
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Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.
Policy bank bonds are those issued by the three Chinese policy banks as the primary source of funding (China Development Bank, Agricultural Development Bank of China, and Export–Import Bank of China).
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.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
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.