Central Bank Dovishness and Good Fundamentals Create Opportunity in Spread Sectors in 2020

This time last year, the general market consensus called for multiple rate hikes and a continuation of monetary policy tightening. But at Western Asset, we weren't so sure of that in light of our view that both growth and inflation would remain moderate. Then, in July, the Federal Reserve (Fed) surprised markets with a significant pivot when it announced what would be the first of three consecutive rate cuts. This helped to propel the bull market that is still charging ahead today.

The Fed's overt focus on inflation outcomes suggests rates will remain "low for long." Given this backdrop and the continued easing by global central banks, we think global growth should improve, spread products should outperform government bonds and, although volatile, emerging markets (EM) should also outperform.

The Fed has moved to directly target inflation, and Fed Chair Jerome Powell has stated that he will stay the course with easy policy until he sees "sustained inflation" above the Fed's 2% target. Central banks around the world also returned to rate cutting in 2019. The European Central Bank (ECB) made a new commitment to lifting inflation and simultaneously downgraded its inflation outlook as ECB President Mario Draghi stepped down.

Global growth slowed in 2019 as trade levels declined along with manufacturing activity; US-China trade tensions were a big part of the problem. US inflation has remained low, even as unemployment has continued to improve to record levels.

Our outlook for the US economy is constructive. The US economy remains solid; this year we expect 2% growth, but inflation will remain tame. We believe that we are in a low-inflation environment, which is likely to persist and implies a low probability of rate hikes this year.