Financial markets have undergone a pretty sharp shift over the past two weeks. Interest rates have rallied while risk assets like credit, equity, and emerging markets have underperformed. Volatility measures are higher, and the Treasury yield curve is now largely inverted.
Invesco Fixed Income believes that several market drivers are at play, in the following order of importance:
1. Elevated trade tensions that reduced global growth forecasts
2. Uncertainty over Federal Reserve (Fed) policy — will the Fed ease aggressively or is it “behind the curve”?
3. Mixed global economic performance
Can the Fed ease the market’s concerns?
Over the past two weeks, perceptions of the Fed have changed. At first, it seemed that the Fed was keeping up with market easing expectations; now, it appears the Fed is falling behind amid declining growth expectations. The driver of this change has been increased trade uncertainty and a weakening global growth outlook.
The inversion of the Treasury curve (when shorter-term Treasury yields are higher than longer-term Treasury yields) suggests that the market is urging the Fed to accelerate its easing program or else face the risk of recession. Without further easing, the market believes tightening financial conditions could drag down consumption. With capital expenditure spending already relatively weak, a consumption decline could risk pushing the US economy toward cyclically low growth rates.
We believe it is becoming increasingly difficult for the Fed to “out-dove” market expectations and generate truly easier financial conditions. For example, the market is currently pricing in a roughly 50% chance of a 50 basis point rate cut in September.1 To “out-dove” that expectation, the Fed would have to deliver a 50 basis point cut and provide further dovish guidance to the market, or deliver an intra-meeting cut. We believe this is unlikely.
Invesco Fixed Income outlook
Invesco Fixed Income’s macro factor framework has pointed to increased market volatility since May, when we forecasted that growth expectations were at their peak. Trade and monetary policy uncertainty are likely to add to market volatility, in our view, and we believe it will be important to monitor some key market developments going forward:
1. Currency markets. So far, the market has avoided a large-scale dollar rally (at least versus developed market currencies). However, periods of financial stress tend to cause dollar rallies, and an appreciating dollar tends to tighten financial conditions globally. We are especially watching the Chinese renminbi for any sharp dislocation, since moves in the Chinese currency have tended to negatively impact global markets.
2. Global central bank communication. Hints that the Fed will not react to current market stress could generate increased volatility.
3. Consumer confidence. Declines in consumption or consumption forecasts could represent danger signs for the economy.
Invesco Fixed Income has been, and continues to be, close to neutral in our stance on credit risk, interest rates, and currency exposure, and we are cautious on overall risk taking. The opposing forces of slowing growth expectations and easier monetary policy are likely to keep the market outlook uncertain in the near term. Bond valuations are not sufficiently compelling, in our view, to justify increasing risk. Rather, we believe it will be necessary to resolve the current dynamic between growth and monetary policy before we add risk to our portfolios.
1 Source: Bloomberg L.P. Aug. 16, 2019.
Important Information
Blog header image: africanpix / iStockphoto.com
A basis point is one hundredth of a percentage point.
Risk assets are generally described as any financial security or instrument, such as equities, commodities, high-yield bonds, and other financial products that carry risk and are likely to fluctuate in price.
An inverted yield curve is one in which shorter-term bonds have a higher yield than longer-term bonds of the same credit quality. In a normal yield curve, longer-term bonds have a higher yield.
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.
The opinions referenced above are as of Aug. 16, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
Rob Waldner
Rob Waldner is Chief Strategist and Head of Macro Research for Invesco Fixed Income (IFI). Mr. Waldner chairs the IFI Investment Strategy team (IST) and is responsible for oversight of the overall IFI investment process; he oversees portfolio risk monitoring and review for IFI portfolios. Mr. Waldner also leads the overall investment and business strategy for IFI’s quantitative strategies. He joined Invesco in 2013.
Prior to joining Invesco, Mr. Waldner worked with Franklin Templeton for 17 years, where he was a senior strategist and senior portfolio manager. He was the lead manager for the firm’s 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 Chartered Financial Analyst® (CFA) charterholder.
James Ong
James Ong is Director of Derivative Portfolio Management for Invesco Fixed Income (IFI). Mr. Ong contributes economic and market analysis to the macro research platform, in addition to leading the IFI derivative strategy and overseeing derivatives held in IFI portfolios.
Mr. Ong began his investment career in 2001. Prior to joining Invesco in 2014, he was a senior vice president, a senior portfolio manager and a senior trader at Hartford Investment Management Company.
Mr. Ong earned his BA degree in economics from Middlebury College. He is a Chartered Financial Analyst® (CFA) charterholder.
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