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Global Debt Quarterly Macro Update: Hemant
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Global Debt Quarterly Macro Update: Meral
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The fourth quarter of 2018 was very consequential for financial markets as global growth concerns led to a sharp reassessment of the path of monetary policy both in the United States and globally. Market turmoil spread to the U.S. equity and credit markets and was no longer confined to emerging markets (EM) and Europe. As the U.S. Federal Reserve (Fed) communicated that interest rates could materially increase, the markets readjusted the degree of risk premium required to own assets.

During this period, however, the U.S. dollar did not appreciate, and, as a result, EM assets denominated in their own currencies did reasonably well. Specifically, for global fixed income portfolios, the largest detractors proved to be U.S. and European high-yielding bonds, with emerging market credit outperforming.

China

A slowing China, tightening financial conditions, and uncertainty about the U.S.-China trade dispute were strong headwinds for Asian emerging markets for most of 2018. Third-quarter figures for gross domestic product (GDP) growth highlighted the increasing divergence between the still robust U.S. growth rate and the rest of the world’s more moderate growth. Since then, the high frequency economic indicators, such as Purchasing Managers’ Index (PMI) data and export numbers from Asia, point to continuing softer growth in the region, especially in China.

Latin America

The emerging market economies of Latin America have seen lackluster growth. Nonetheless, we expect a growth recovery in Latin America for all countries, except for Mexico, where the U.S. slowdown, combined with uncertainties over Mexican government policy, will reduce growth in 2019. Growth for the Latin American region is likely to double to 2% from last year, provided Argentina’s economy stops contracting, and, in our view, the economic program there is on the right track. In Brazil, economic activity remains at a slow pace for now, despite incipient signs of improvement, such as the widespread increase in consumer and business confidence indicators. We forecast a recovery toward 3% this year, assuming progress with the pension reform efforts now underway supports this more benign environment.

Outlook

We believe that global growth momentum slowed significantly and all forward-looking data indicate that in the near term the rate of change for growth will remain negative. For the investable world, we believe growth slowed from nearly 3.4% to closer to 3.1%. We expect further near-term weakness, however, we do expect that China will be successful in stimulating growth in the second and third quarters of 2019, and that could allow the average growth rate for the country in 2019 to be stable. The domestic drivers of growth in almost every region, with the possible exception of China, remain stable, albeit with significant weakness in trade. In Europe, we expect the headwinds from one-off factors to diminish, with looser fiscal policy in Germany and France providing some additional momentum.

We expect that monetary policy globally will be far more supportive of growth than was the case in 2018. We expect that the Fed is currently on hold and that the pause on any further rate hikes could be fairly extended. The European Central Bank has announced that significant monetary policy stimulus may be needed to counter the recent weaker economic data. Most emerging market central banks will be on hold without any further necessity to tighten policy. Real policy rates in EM countries are now at a decade high. The high real rates also highlight the fact that inflation remains muted globally, and there is little near-term risk of it accelerating meaningfully.

While we will closely monitor global conditions, we do not expect that the slowdown will reach a point when we would become concerned about recession and its impact on asset prices. We do expect that the materially improved policy environment will drive asset prices, and we expect that shift to be positive.

Portfolio Implications

From an asset valuation perspective, we believe that the U.S. dollar will resume its decline, and that decline could possibly accelerate in the second half of 2019 as the global growth differential to the U.S. widens. We continue to think that the medium-term trend for the dollar is lower, continuing the decline that started in 2015, and only interrupted in 2018 because of the large fiscal stimulus in the U.S. With the expected slowdown in U.S. growth to 2% or lower, we think the long weaker U.S. dollar cycle can resume correcting for the overvaluation in the currency. EM currencies can benefit from interest rate differentials while developed market (DM) currencies could benefit from valuations.

We continue to favor EM interest rates over DM interest rates. Real yields in emerging markets remain close to decade highs when compared with a combination of developed market yields. For those countries where the central banks have raised rates, we see value in the short-term rates. In the countries where the central banks have not fully tightened, we see value in long-term bonds, particularly if the yield curves are very steep.

The largest opportunity that has opened up as a result of the fourth-quarter turmoil is in credit. We think that European high yield and financials are now among the cheaper sectors globally, and offer significant opportunities for excess return over our investment horizon. We continue to believe that European financial subordinated debt offers value, as do emerging market hard currency sovereign and corporate debt.