Global Fixed Income Views: Second quarter 2019

2 April 2019

Themes and implications from the Global Fixed Income, Currency & Commodities Investment Quarterly

In Brief

  • We lowered slightly our base-case scenario, Above Trend Growth, from a 50% probability to 45% and slightly raised the probability of Sub Trend Growth from 35% to 40%. A soft landing, with growth roughly at trend, appears likely for the global economy.
  • U.S.-China trade negotiations still top our list of concerns; if the trade battle escalates, the impact on business spending and consumer sentiment will be globally significant.
  • We don’t see recession in 2019 or early 2020—we believe the Federal Reserve (Fed) unambiguously ending three years of tightening, and other central banks’ dovish tilts, have extended the cycle. We left the probability of Recession unchanged at 10%, although even a minor policy error could raise that.
  • We are encouraged to fully embrace the bond market again and want to be buyers of every backup in yields or widening in credit spreads. Among our top picks: external and local emerging market (EM) debt and currency, BBB corporates, high yield credit and loans, and short-term securitized credit.

SCENARIO PROBABILITIES (%)

Source: J.P. Morgan Asset Management. Views are as of March 21, 2019.

MARCH MADNESS

Anyone in the U.S., or passing through this time of year, knows all too well about the collegiate basketball spectacle known as March Madness.1 This year, the Federal Reserve one-upped the ballers by unleashing its own version of March Madness the day before the official start of the tournament. The Fed’s unambiguously ending three years of monetary policy tightening not only left policy rates where they are but also included a surprisingly detailed plan for concluding the balance sheet runoff. It confirmed the dovish tilt of the last several months and validated the dovish posture adopted by a growing number of other central banks, which toppled like dominoes once the Fed made that first move. What more could a fixed income investor ask for? But now the hard work begins. Does one chase the bond market here, with its flat yield curves and narrower credit spreads? Or does one try to wait for a consolidation and hope to get in ahead of the loads of cash sitting on the sidelines—before investors get over the sticker shock and cash starts piling in again? Such was the backdrop for our March 21 Investment Quarterly (IQ), held in New York.

MACRO BACKDROP

The problem with a global growth slowdown is the unknown of whether it ends in a soft landing or recession. With the central banks signaling their unwillingness to risk a monetary policy-led recession, the odds of a soft landing have clearly increased and the late-cycle recovery should extend. Although the data has softened, the U.S. economy is far from recession. The consumer, two-thirds of the U.S. economy, is in fantastic shape—enjoying a strong balance sheet, full employment and wage growth.

Any de-escalation of trade tensions between the U.S. and China will only increase business confidence and spending. And what’s not to like about China? A combination of fiscal and monetary stimulus seems to have stabilized the economy and helped to counter the drag resulting from trade pressures. We expect China’s growth to be supported at around 6.3%–6.4% in 2019, as opposed to the 5.9% we feared three months ago. Last, despite concerns on Brexit, Italian deficits and trade, the eurozone looks reasonably stable. The combination of the European Central Bank on hold for the foreseeable future and fiscal austerity giving way to fiscal stimulus in France and Italy should be supportive of the broader economy. While we are certainly not expecting the array of global policy stimulus to lead to a GDP surge reminiscent of 2017 and 2018, we also cannot see the onset of recession. The central banks can comfortably sit with rates and balance sheets where they are—under cover of inflation that remains stubbornly below their targets.

Scenario expectations

We reduced the probability of our base-case scenario of Above Trend Growth to 45% from 50%. We consequently raised the probability of Sub Trend Growth to 40% from 35%. It does appear as though the global economy will glide toward a soft landing with growth roughly at trend, perhaps a little bit above or below. The outcome of the U.S.-China trade negotiations and Brexit will surely be important in determining which side of trend growth we will see.

We kept the probability of Recession unchanged at 10%. We do believe that the central banks have extended the cycle, and we don’t see recession as a 2019 or early 2020 event. The Fed’s preference for looking at average inflation through a cycle suggests that it is trying to protect against prematurely tightening, or overtightening, monetary policy. But we are late cycle, and a policy error, however minor, might be enough to bring forward that probability.

Finally, we kept the probability of Crisis at 5%. Geopolitics are a constant concern but, for now, cooler heads and rational thinking seem to be prevailing.

Risks

U.S.-China trade negotiations remain at the top of our list of concerns. If the trade battle escalates, the impact on business spending and consumer sentiment will be globally significant, with the potential to lead to a dangerous stagflationary spiral.

A hard Brexit would also be a challenge for the eurozone and global economy to absorb. Perhaps it is already being somewhat mitigated, as many companies are already executing on their new location strategies.

Further out, we have the U.S. 2020 general election. As 2019 progresses, we are likely to hear from a growing chorus of campaigners with less market-friendly views … think an array of higher taxes and greater regulation.

STRATEGY IMPLICATIONS

A soft landing, dovish central banks and the promise of compromise between the U.S. and China and the UK and the eurozone encourage us to fully embrace the bond market again. We want to be buyers of every backup in yields or widening in credit spreads. There is potentially a significant pool of money sitting in cash equivalents looking to enter this market, with investors who once believed that they would get a much better entry point.

Here are a few of our top picks:

Emerging market debt. External, local market and EM FX all look appealing. They have lagged the other markets and stand to benefit the most from a complacent Fed and a U.S.-China trade resolution.

BBB rated corporates. In our view, the market became heavily oversold as concerns over leverage and recession built. With some deleveraging underway and a stable economic backdrop, the growing overseas demand for investment grade credit should find its way into this market.

High yield credit and loans. Everyone wants to buy it cheaper, but it never seems to get there. Expected low default rates and recession risks beyond the horizon should continue to generate inflows into this market.

Short-term securitized credit. Keep riding the winner. Strong consumer balance sheets should continue to be a tailwind for this market.

CLOSING THOUGHTS

The market expected the Fed to keep raising rates well into 2019 and even into 2020. That, combined with the balance sheet runoff and hawkish rhetoric from many other central banks, suggested that yields would be moving higher and credit spreads would be widening. Money poured into liquidity, short duration and absolute return bond funds as investors prudently waited out the expected carnage. The abrupt pivot by the Fed and other central banks caught the market flat-footed. While money already in bonds has covered shorts, the cash sitting on the sidelines has yet to enter in earnest. At some point, there should be a grudging acceptance of the new reality: It’s time to embrace your bond portfolio manager again. Welcome to March Madness.

SCENARIO PROBABILITIES AND INVESTMENT IMPLICATIONS: 2Q19

Every quarter, lead portfolio managers and sector specialists from across J.P. Morgan’s Global Fixed Income, Currency & Commodities platform gather to formulate our consensus view on the near-term course (next three to six months) of the fixed income markets. In daylong discussions, we review the macroeconomic environment and sector-by-sector analyses based on three key research inputs: fundamentals, quantitative valuations and supply and demand technicals (FQTs). The table below summarizes our outlook over a range of potential scenarios, our assessment of the likelihood of each and their broad macro, financial and market implications.

Source: J.P. Morgan Asset Management. Views are as of March 21, 2019.

Opinions, estimates, forecasts, projections and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.

1National Collegiate Athletic Association Division I college basketball national championship.


BUILD STRONGER FIXED INCOME PORTFOLIOS WITH J.P. MORGAN

We have built and evolved our fixed income capabilities with just one aim: to build stronger portfolios that solve our clients’ needs. Today we are one of the top fixed income managers in the world.

Diverse perspectives, integrated solutions:

  • Access the power of a globally integrated team of investment professionals and our proprietary research, encompassing fundamental, quantitative and technical analysis.
  • Benefit from actionable insights designed to help you invest with conviction, from our regular macro and market views to our fixed income portfolio construction tools.
  • Choose from a wide variety of outcome-oriented solutions designed to address all your fixed income needs.
  • Tap into the proven success of one of the world’s largest fixed income managers, with broad experience gained across regions and market cycles.

Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops. Securities with greater interest rate sensitivity and longer maturities tend to produce higher yields, but are subject to greater fluctuations in value. Usually, the changes in the value of fixed income securities will not affect cash income generated, but may affect the value of your investment. Credit risk is the risk of loss of principal or loss of a financial reward stemming from a borrower’s failure to repay a loan or otherwise meet a contractual obligation. Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. Such default could result in losses to an investment in your portfolio.


Disclaimer

*FX: foreign exchange; MBS: mortgage-backed securities; IG: investment grade; DM: developed market.

For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programs are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programs, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide.

To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our Company’s Privacy Policy. For further information regarding our regional privacy policies please refer to the EMEA Privacy Policy; for locational Asia Pacific privacy policies, please click on the respective links: Hong Kong Privacy Policy, Australia Privacy Policy, Taiwan Privacy Policy, Japan Privacy Policy and Singapore Privacy Policy.

This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other European jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K), or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd (Co. Reg. No. 201120355E); in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients’ use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA; and J.P. Morgan Investment Management Inc.

In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only.

Copyright 2019 JPMorgan Chase & Co. All rights reserved.
PI-GFIV_2Q19 | 0903c02a81d2d0a6

0903c02a81d2d0a6

2 April 2019
Contributor

Robert Michele

Managing Director and Chief Investment Officer Head of the Global Fixed Income, Currency & Commodities Group

Building stronger fixed income portfolios for the future

View products