Source: Guide to the Markets – Asia, page 17

• Global PMIs are approaching the end of 2019 on a weak note.

Protectionist policies weighing on capex

• U.S.-China trade tensions, and the rising specter of protectionist politics exemplified by Brexit, have impeded many companies’ ability to make investment decisions in recent months. This is unlikely to change soon; even as U.S. President Donald Trump postponed some tariffs and China waived others, the threat of a trade war continues. Manufacturing purchasing managers’ indices (PMIs) globally declined through the northern summer but appear to be stabilizing at a low level.

• Consumers continue to be the pillar supporting growth, shoring up a number of key economies around the world aided by low unemployment rates. Consumer strength underpins our view that the global economy will probably avoid a sharp slowdown in the months ahead. However, we are closely watching corporate sentiment, which has been cautious, for signs that caution could tip toward slower hiring and wage inflation.

Source: Guide to the Markets – Asia, page 29

• U.S. consumers are still supporting the U.S. economy.

Watching for U.S. recessionary signals

• The inversion of the U.S. Treasury yield curve prompted concerns that a recession is on its way. We have previously highlighted that years of quantitative easing have weakened the signaling effect of the curve’s slope. Historically, there has also been a considerable time lag between curve inversion and recession. We should not ignore it, but nor should it be the sole indicator we use.

• U.S. business confidence, new orders and jobs numbers have softened in recent months but are still some distance away from thresholds consistent with recessions. Credit conditions remain accommodative and household balance sheets remain in good health.

Source: Guide to the Markets – Asia, page 23

• The Fed’s rate cuts have opened the door for other central banks to follow suit.

Some central banks are approaching their limits

• Global central banks have turned decidedly dovish in 2019. Since the start of the year, emerging market central banks have already cut rates 30 times, in many cases unexpectedly. Developed economies’ room for easing is more limited. The European Central Bank adopted a zero interest rate policy (ZIRP) in 2016 and has negative deposit rates. The Bank of Japan has run similar policies in recent years. It is hard to see how these central banks could push rates any lower without hurting banks’ appetites to lend and savers’ purchasing power.

• Officials at the U.S. Federal Reserve (Fed) will likely be persuaded by the strength of the U.S. consumer that a long series of rate cuts is not necessary at this stage. Real interest rates are already negative at the long end of the yield curve, which should keep corporate borrowing costs low. These factors imply that the Fed will be measured when it comes to monetary easing in the months ahead.

Source: Guide to the Markets – Asia, page 26

• More fiscal stimulus is needed to protect economic growth.

Fiscal boost would need political coordination

• With limited room for monetary stimulus in most major economies, fiscal stimulus is expected to play a crucial role in supporting growth. Falling funding costs are also allowing governments to borrow more cheaply. However, not all governments will approach stimulative policies in the same way.

• We expect China to pick up the pace of government spending, especially in infrastructure, since it already reduced taxes and government fees earlier this year. Beijing has also announced policy reforms designed to boost consumption. In Germany and Japan, governments can borrow at negative interest rates but policymakers will need to review their fiscal discipline principles to inject stimulus into their economies. In the U.S., President Trump strongly favors introducing another fiscal package to boost the economy going into the 2020 election year, but this would likely face considerable resistance in Congress.

Source: Guide to the Markets – Asia, page 50

• The supply of negative yielding bonds has reached record levels.

The race to zero

• The unremitting trade war between China and the U.S. and the rise in other threats to global growth have spurred a dramatic reversal in monetary policy. Numerous central banks in emerging and developed markets have started to cut interest rates and some have suggested they will adopt unconventional measures, if needed, sparking the possibility of a race to zero interest rates.

• Against this backdrop, the supply of negative-yielding bonds has surged. Currently, around one-third of the global government bond market trades with a negative yield and they are appearing in ever more countries. The bonds of several European countries, including Germany, Denmark, Finland and the Netherlands, offer negative yields across their entire curve. Negative yields are not limited to government bonds; the share of the corporate bond market offering less than 0% yield is also on the rise.

Unintended consequences

• By making money as cheap as possible, central banks hope to spur borrowing and spending to stimulate economic activity. This does happen in the near term, but negative cash rates penalize savers and holders of interest-bearing assets, which may harm the growth outlook in the longer run.

• Meanwhile, the growth in negative-yielding bonds could become self-propagating. Large institutional investors, such as pension funds and insurance companies, are required to hold higher-quality fixed income assets regardless of yield. These buyers may wish to lock in yields before they fall even further, which creates demand and pushes bond yields lower still.

• One consequence may be to drive an international hunt for yield and demand for U.S. Treasuries, which offer a relatively high yield.

Source: Guide to the Markets – Asia, page 56

• U.S. consumers’ resilience undergirds the market for securitized assets.

Source: Guide to the Markets – Asia, page 51

• Income and protection together are rare in fixed income market.

Chasing yield

• The policy guidance offered up by central banks, particularly the European Central Bank, has been a willingness to cut rates further and resume bond buying programs or other unconventional policy measures. This means that bank deposit rates are likely to fall further, making large cash allocations likely to remain unattractive for some time to come.

• The low interest rate environment also means that investors will remain yield chasers, likely offering support to the extended sectors of the fixed income market and other asset classes where it is possible to earn higher income through an illiquidity premium.

• Corporate credit markets globally offer relatively attractive risk-adjusted returns over government bonds, given current low default rates and a steady pace of deleveraging. However, investors need to carefully consider credit quality and market liquidity.

• The resilience of the U.S. consumer makes the yield pickup available in U.S. asset-backed securities, such as mortgage-backed securities, an attractive proposition. Healthy household balance sheets and low debt-servicing costs are keeping mortgage delinquency rates in check.

• Alternative income streams from real assets are another source of yield that may be less correlated to economic activity and can also provide portfolios with an additional layer of diversification. These types of assets usually involve a trade-off, however, between yield and liquidity.

• Close to USD 17trillion in negative-yielding bonds, and a U.S. yield curve that has at times inverted, suggest that market risks have risen. While a near-term recession may be avoided, investors will have to be active in managing liquidity, default and other market risks as we move further into the late stage of the economic cycle.