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We expect US interest rates to remain range-bound due to moderating gross domestic product (GDP) growth and looming US Treasury supply. Growth over the next few quarters will likely be driven by consumption and capital expenditures supported by US tax reform. We believe the market will begin to price in a less positive growth picture in 2019, as the effects of tax stimulus wear off and the impact of tighter Federal Reserve (Fed) policy begins to take hold. We could see below-trend growth in the second half of 2019. Additionally, core US inflation has begun to soften, and in the coming months we expect softer rental and service inflation to drive core consumer price inflation below 2% (excluding tariff-related price increases). In addition, US Treasury supply has continued to increase in 2018 while Fed purchases have declined. This combination has led to increased volatility in the Treasury market.
The recent weakening of eurozone economic momentum has not altered the European Central Bank’s (ECB) central view that risks to growth are broadly balanced. ECB President Mario Draghi pointed to a number of factors, including the German auto sector, trade uncertainties and Brexit, arguing that growth is moving back toward trend from what was an especially strong performance last year. Draghi also expressed confidence in a gradual rise in inflation and maintained a firm tone on Italy, which confirmed the ECB’s strong bias to end net asset purchases in December. Meanwhile, 10-year German bund yields fell from the early October peak of 0.57%1 to around 0.37%2 by month-end, driven by fears of escalating tensions between the European Commission (EC) and the Italian government over Italy’s proposed budget. We are neutral European duration for now as we believe the situation in Italy may worsen before it gets better.
We are slightly underweight Chinese interest rates, and expect a relatively cautious mood in the China onshore rates market in the coming month. Bullish sentiment in this market following weaker-than-expected credit data reversed after major financial regulators stated their strong intention to stabilize the economy and equity market. A personal tax cut was also announced in late October, and the People’s Bank of China announced re-lending measures to support bond financing for small and medium-sized enterprises. We think liquidity will remain reasonably loose in the medium-term, but investors may cut duration and add risk via the credit market due to the recently announced series of supportive measures.
The 10-year Japanese government bond yield has broken out of the range first established after the Bank of Japan (BOJ) pushed interest rates into negative territory in January 2016. The catalyst for October’s move higher has likely been a combination of reductions in the BOJ’s quantitative easing purchase program and increases in global yields. However, yields lost upward momentum later in the month due to flight-to-quality demand following the selloff in global equity markets. It is likely the BOJ will continue to cap 10-year yields at 0.20% until it sees a sustained rise in underlying inflation dynamics. Because we also see no catalyst for yields to move lower, we are maintaining our neutral position.
Brexit negotiations pose a significant possible downside risk to UK assets, and we believe this will likely overshadow any positive near-term macro developments. However, higher-than-expected GDP and wage growth in July have raised the prospect of earlier and faster Bank of England rate hikes if Brexit uncertainty subsides. If interest rates rise on a Brexit agreement, we believe the adjustment is likely to be relatively modest, since markets are already pricing in a gradual hiking cycle. Additionally, the UK consumer remains highly leveraged and, therefore, sensitive to increasing rates.
The Canadian economy appears to be holding up with GDP growth slightly above 2.0%3 and inflation near the midpoint of the Bank of Canada’s (BOC) 1.0% to 3.0% target.4 The new trade agreement between the US, Canada and Mexico appears to have lifted business sentiment, but oil transportation bottlenecks have depressed the price of Western Canadian Select crude oil. All signs point to the BOC continuing its gradual path of tightening the overnight rate. Canadian 10-year rates touched 2.60% in October, the highest level of the year, but have since trended back down below 2.50%.5
The Reserve Bank of Australia (RBA) kept its policy rate stable in October and released a statement nearly identical to the previous month. In the minutes, the RBA stated that it remains upbeat on the economy and expects solid growth, though more moderate than in the first half of the year. The RBA also repeated that its next policy move will likely be an increase in interest rates, but there is no strong case for a hike in the near term. The September employment report remained strong, with the unemployment rate dropping to 5.0%.6 However, much of this drop was likely due to a decrease in the participation rate and, therefore, would be unlikely to cause the RBA to change its stance. Because the RBA will probably not raise its policy rate soon, we see no drivers to move interest rates for now.
We find current yields attractive from a valuation perspective. Consumer price inflation has softened in recent months, with the September headline figure at 3.77%.7 We expect inflation to hover around 4.0% in the coming months, making it unlikely to become a driving factor of yields in the near future. However, the Reserve Bank of India has changed its stance to “calibrated tightening,” meaning it may raise interest rates at its December meeting to contain rupee volatility and potential inflation caused by the rupee’s recent decline. Therefore, we believe that risks are balanced for Indian government bonds, and we are staying on the sidelines until we see a clear shift in risk sentiment.
1 Source: Bloomberg L.P., Oct. 5, 2018.
2 Source: Bloomberg L.P., Oct. 26, 2018.
3 Source: Statistics Canada, Sept. 28, 2018.
4 Source: Bank of Canada, Oct. 2016.
5 Source: Bloomberg L.P., Oct. 5, 2018 to Oct. 25, 2018.
6 Source: Australian Bureau of Statistics, Oct. 18, 2018.
7 Source: Bloomberg L.P., Oct. 12, 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.
The consumer price index (CPI) measures change in consumer prices as determined by the US Bureau of Labor Statistics. Core CPI excludes food and energy prices.
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 Portfolio Management
Rob Waldner is Chief Strategist and Head of Multi-Sector Portfolio Management 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.