Brad Tank, Chief Investment Officer—Fixed Income
Consensus views on the global economy and fixed income markets have been disrupted frequently over the past year—by unexpectedly weak economic growth, disappointments in China, battered commodity prices and uncertain U.S. monetary policy. As we seek to anticipate the environment for 2016, many of the same elements are largely in play, with major implications for market psychology and performance.
For nearly a decade, the world has been awash in unprecedented monetary accommodation, but now the U.S. Federal Reserve is creeping through a painful transition to higher rates—a shift that has been delayed by weak growth trends and complicated by the bias of other developed markets toward easing, as well as the Fed’s rather ineffective approach to messaging, which has added to volatility. The path toward policy normalization could take several years and likely remains an overhang for the markets. On the flipside, accommodation in other developed markets is likely to, if anything, accelerate, as Europe seeks to sustain moderate economic momentum and Japan looks to regain its footing.
Another key factor for 2016 and beyond is China. Although the country’s markets managed to regain some stability after late summer turmoil, it took extraordinary efforts by the government (whose currency devaluation had worsened investor fears in the first place) to make it happen. Now, the path of growth in China remains the focus of enormous attention, given its ever-expanding role in the world economy.
Of course, the volatility isn’t an isolated phenomenon, but reflects China’s multi-year transition from a manufacturing-driven to service-driven economy, a shift that we believe is crucial to achieve sustainable, consistent growth. For context, it bears noting that even a 5% growth rate from China for 2016 would represent a greater absolute contribution to global GDP than the country provided at a 15% growth rate back in 2007. So it’s a big ship, but we think it can successfully change course over time. The Chinese government and central bank have many tools (and resources) at their disposal, and notwithstanding miscues to the contrary, seem set on getting things right in the end.
Their potential success (or failure) naturally has ramifications elsewhere. In particular, an intensifying slowdown in China would likely further dampen commodity prices, worsening the pain for many already challenged emerging markets and commodity-sensitive credits. More broadly, it could have knock-on effects on developed markets as demand for emerging markets imports eases. Naturally, all this could have a negative impact on risk assets, and alter the prospects for global growth and inflation.
What’s the takeaway for fixed income investors? Primarily, it’s that uncertainty is likely to continue in 2016, potentially exacerbated by geopolitics and a disruptive U.S. Presidential election cycle. This isn’t entirely negative, as volatility can provide opportunities to capitalize on mispriced assets—particularly for investors who have the ability to move across sectors and regions.
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