Interest rate outlook: Eurozone economy now in “Goldilocks” phase
Invesco Fixed Income shares its views of rates around the world
The risks around the French elections are now behind us, and we are unlikely to face a far right insurgency in the next electoral test: Germany. In the background, European data continue to be solid and resilient to political risks. Given the French election’s market-friendly outcome, we expect a renewed focus on fundamentals and European Central Bank (ECB) watching going forward. As post-election short covering winds down, we expect European core yields to resume their upward trend and peripheral spreads versus German bunds to widen again. The periphery could come under more pressure in the unlikely event that early elections are held in Italy.
Stronger global growth is likely to be supportive of higher US yields and normalization of global central bank policy. Market anticipation of the end of global quantitative easing (QE) programs should drive US yields higher. We expect the US Federal Reserve (Fed) to hike rates two more times this year as well as announce a reduction in the reinvestment of principal payments from its securities holdings.
The onshore Chinese government bond (CGB) yield curve bear flattened (short-term rates rose faster than long-term rates) in the first half of May. This was mainly due to selling pressure from (1) bond funds faced with rising redemptions from banks and (2) banks’ own trading and investment books. Banks were forced to reduce their fund investments after China’s bank regulator mandated reduced banking sector and interbank (including non-bank financial institution) leverage. Together with tightened macroprudential rules, we believe this move will slow broader credit growth in the second and third quarters and negatively impact economic growth momentum in the second half of this year. Therefore, we remain cautious on CGBs in the near term, but bullish in the medium term.
The Bank of Japan (BOJ) has been quietly tapering its QE purchases recently without drawing much attention to its efforts. This comes amid a weak inflation backdrop and likely continued disappointment as indicated by the Citi inflation surprise index. We would expect the central bank to continue with such an approach over the near term and to retain its 10-year Japanese government bond yield target of “around zero.” Such an approach will keep the BOJ on the same path as other major central banks (i.e., tightening policy) while providing the greatest level of flexibility to reverse course should incoming data warrant it. We believe BOJ Governor Kuroda remains very much in control.
We could well see an increase in Brexit rhetoric (from both sides) in the run-up to the UK general election on June 8. Now that Article 50 has been triggered, the Europeans will be seeking to set the tone for the talks that lie ahead. Some of the preliminary tactics adopted have not been well received in the UK. A continuation of such tactics is also unlikely to be well received by the UK Prime Minister, Theresa May, particularly as she travels the country seeking votes over the next month. Her stance may come across as overly harsh during this time. While we expect the UK economy to weaken as the year progresses, we believe that the market consensus is overly pessimistic. We expect gilts to underperform both US Treasuries and bunds in the short-to-medium term.
During the recent rate rally, the Canadian 10-year government bond yield held at 1.45% and has bounced slightly from there, but remains at the lower end of its recent range.1 Economic data have tapered off from the strong rebound seen in the first quarter, and the Bank of Canada continues to keep monetary policy on hold. Recently imposed US tariffs on Canadian softwood exports raised concerns about broader trade implications. In addition, a Canadian subprime mortgage lender has experienced a liquidity drain, drawing attention to an area of the mortgage market that is not typically in the news. We would expect Canadian yields to remain supported in any sell-off.
The Reserve Bank of Australia (RBA) held rates steady at 1.50% at its May 2 meeting as expected.2 The statement noted upbeat global economic conditions and labor growth, but cautioned about the recent decline in commodity prices and the likelihood of low wage growth going forward. The RBA remains concerned about the housing market, stubbornly high unemployment and lower-than-desired inflation. With all these concerns and current conditions, the RBA is likely to remain on hold for the foreseeable future. We remain neutral on Australian interest rates.
Rob Waldner, Chief Strategist; James Ong, Senior Macro Strategist; Noelle Corum, Macro Analyst; Sean Connery, Portfolio Manager; Brian Schneider, Head of North American Rates; Scott Case, Portfolio Manager; Josef Portelli, Portfolio Manager; Ken Hu, CIO Asia Pacific; Yi Hu, Senior Credit Analyst; Alex Schwiersch, Portfolio Manager
1 Source: Bloomberg L.P., May 11, 2017
2 Source: Reserve Bank of Australia, May 2, 2017
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.
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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.
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Interest rate outlook: Eurozone economy now in “Goldilocks” phase by Invesco