Global Outlook Active Global Fixed Income Fourth Quarter 2016 1 - - PowerPoint PPT Presentation

Global Outlook Active Global Fixed Income

Fourth Quarter 2016

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Major Macro Challenges for Markets in 20 16

Source: SSGA QE = Quantitative easing “Brexit” = Britain exit from European Union Fed = US Federal Reserve

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CHINA

• Risk of RMB devaluation
• Credit and Investment bubbles
• Housing % GDP over 3x US peak

FE D

• Focus on global developments
• Cautious inflation outlook
• Slower pace of rate hikes

GE OPOLITICAL

• Middle‐East tensions
• Oil prices ‐ lower range
• Political instability

E UROPE

• Migrant crisis
• QE distortions
• Fears of “Brexit”
• Boost from weaker Euro fading

US Japan

• 2% inflation by mid‐2017?
• Diminishing return from policy

actions

• Capital flows moving overseas
• Liquidity issues in JGB Market

€

$

¥

• Controversial Presidential election
• Congressional gridlock
• Weak external environment

weighs on outlook

Bouts of volatility keep global governm ent bond yields w ell supported

Global Bond Market Landscape

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Source: SSGA ECB = European Central Bank BOE = Bank of England BOJ = Bank of Japan

• Fed slows normalization

pace

• ECB and BOJ increase QE
• “Brexit” risk delays BOE

action

• China - RMB stability

preferable

POLICY

Convergence

E CONOMY LOW-FLATION

RE BALANCING GROWTH Oil, USD and Wages

• Loose policy in Europe and

Asia

• Modest help from fiscal

policies

• Shrinking output gaps –

though still negative

• Central bank caution –

asymmetric risks in global

• utlook and lower oil price
• Less upward pressure on

USD with fewer rate hikes

• Low productivity and

subdued wage growth

US Fixed Income Market – Volatility

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• Volatility is at historically low levels, which increases demand for carry
• Investors try to source carry from higher yielding sectors and selling volatility
• Negative feedback loop ‐ increased demand to sell volatility at such low levels erodes the risk

premium received by investors

• Is yield premium appropriately priced for level of risk?

Source: Bloomberg Data as of September 30, 2016

60bp avg = 94bp 50 100 150 200 250 300 Jan‐00 Jan‐02 Jan‐04 Jan‐06 Jan‐08 Jan‐10 Jan‐12 Jan‐14 Jan‐16

bp

Volatility is at historical lows

MOVE Index avg.

US Fixed Income Market - Volatility

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• Reactions to geopolitical events or monetary policy communication mistakes could result in

market corrections that are exacerbated by current positioning

• Low level of risk premium decreases “yield cushion” which helps investors to hold into volatility

events

• Investors search for yield has driven portfolio allocations into lower credit, less liquid, unfamiliar

sectors, which could potentially result in increased selling pressure in response to vol events

Source: Bloomberg Data as of September 30, 2016

0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60 Standard Deviation (Yield %)

Rolling 120 day Volatility over time

US 2Y Germany 3Y Italy 3Y US 10Y Germany 10Y Italy 10Y US Taper Peripheral crisis Greece Summer 15 Similar levels to current Similar levels to current Lehman Brothers

Key Drivers of Lackluster Global Growth

• 1. Global excess slack:

Output gaps are negative and labor market slack persists

• 2. Weak productivity growth: Lack of business investment
• 3. Lower potential GDP:

Demographics and weak productivity

• 4. Limited policy options:

monetary policy exhausted, little appetite for fiscal stimulus

As of September 29, 2016

Lackluster Global Growth Continues

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The above forecast is an estimate based on certain assumptions and analysis made by the SSGA Economics Team. There is no guarantee that the estimates will be achieved. This is not a prediction or projection of actual growth.

'70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 1 2 3 4 5 6 7

Sources: IMF, Oxford Economics, SSgA Economics Team 2016 and 2017 are forecasts.

Global Growth

World GDP, % chg y/y Historical Growth Trend (3.7%)

Global Bond Yields Grinding Ever Lower

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As of September 29, 2016 Past performance is not a guarantee of future results.

Negative Yields on the Rise

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Source: SSGA As of 30 July 2016 Past performance is not a guarantee of future results.

5 10 15 20 25 30 35 40 Jun‐11 Dec‐11 Jun‐12 Dec‐12 Jun‐13 Dec‐13 Jun‐14 Dec‐14 Jun‐15 Dec‐15 Jun‐16

% of Index with Negative Yields Global Bond Indices

Aggregate Treasury Gov‐Related Corporate Securitized