Global Fixed Income Views 4Q 2018 - J.P. Morgan Asset Management

Global Fixed Income Views 4Q 2018

Contributor Robert Michele

Themes and implications from the Global Fixed Income, Currency & Commodities Investment Quarterly meeting

In brief
  • We have reduced our base-case scenario, Above Trend Growth, to a 70% probability in response to escalating tariff battles and the potentially negative impact on trade; otherwise, the global economy is in very good shape.
  • The Federal Reserve (Fed), seeing 3-4% GDP growth and low unemployment, can continue marching toward normalization, suggesting a 3% fed funds rate and further balance sheet rundown.
  • We consider the stronger dollar unsustainable and expect it to correct as we enter 2019.
  • We continue to like carry and credit. Favorite sectors include U.S. and European high yield and leveraged loans, as U.S. consumers enjoy the strongest balance sheets in decades; short-duration securitized credit; and emerging market debt, where potential trade wars and a strong dollar appear to be priced in.

Scenario probabilities (%)

Source: J.P. Morgan Asset Management. Views are as of September 13, 2018.


As we approach year-end, the calm heading into 2018 is now a distant memory. Instead, we are awash in a sea of divergences: economic growth, interest rates, trade, monetary policy and politics. Investors will now have to grapple with these issues as they decide how to allocate capital. What is different this time is that they will have to do so without the backstop of the central banks. Quantitative easing (QE) is evolving into quantitative tightening (QT), so that sea of cash that indiscriminately supported all asset prices will not be there to cover up “mistakes” going forward. This doesn’t mean that there won’t be opportunity. It just means that investors will have to once again roll up their sleeves, do the detailed research and uncover the treasures from the trash. Such was the backdrop for our September 13 Investment Quarterly (IQ), coincidentally held in London, the site of another pending divergence, Brexit.


Once again, we noted that the global economy looked fine. The U.S. continues to chug along at a 3%–4% GDP growth rate, with low unemployment and rising wages. While a lot of this growth has been driven by fiscal policy, the Federal Reserve (Fed) has met its dual objectives and can continue its march toward normalization. For us, that means a 3% fed funds rate and further balance sheet rundown. But the U.S. and the Fed do seem to be going it alone. European and Chinese growth have slowed a bit, and their central banks are responding with caution. The European Central Bank (ECB) has indicated it will be at least another year before it begins to raise rates from -0.40% and the People’s Bank of China (PBoC) has cut rates and let the currency drift lower as it seeks to offset some of the impact of the tariffs scuffle with the U.S. All of this has led to a stronger dollar—unsustainably so, in our view. Entering 2019, we expect the dollar to correct as global growth and interest rate expectations stop diverging.

Economic expectations

We spent a fair amount of time discussing whether to leave our base-case scenario of Above Trend Growth unchanged at a 75% probability or to lower it in response to the escalating tariff battles. Ultimately, we felt increased tariffs would lead to less trade and consequently reduced our base case to a 70% probability. Outside of the tariffs, the global economy is in very good shape. Almost all regions are growing above trend, and the central banks are reluctant to normalize policy at a meaningful pace. As long as inflation remains moderate, they can stay behind the curve, perpetuate the distortion, and support with bloated balance sheets and negative real policy rates.

We raised our probability of Sub Trend Growth from 20% to 25% to acknowledge the potential impact of broad tariffs. It was noted that China had already begun to slow from its 6.5% growth rate, as planned deleveraging was underway. While we appreciated that PBoC easing and a weaker currency could offset most of the initial impact of tariffs, it would be a lot for the Chinese economy to absorb tariffs on the entire (approximately $500 billion) of exports, or tariff rates rising from 10% to 25%. In the worst-case scenario, we could see Chinese GDP falling to 4.5%. There would also be a broader knock-on effect to the rest of the emerging markets.


We left the probability of Recession at 0%. Fiscal stimulus in the U.S., a well-capitalized global banking system, strong U.S. consumer balance sheets and central banks that are overly cautious in restoring normality to the system are on the growing laundry list of reasons not to expect a recession any time soon. There was some discussion about the flattening U.S. yield curve, which has historically been a reasonable indicator of approaching recession. We felt the monetary distortions present in this cycle were a meaningful difference accentuating curve flattening. We’ll see how the next couple quarters play out for the curve as QE gives way to QT and the tax reform incentive for U.S. plans to contribute to their pension funds ends.

We also kept the probability of Crisis at 5%. A potential trade war, QT, rising interest rates and geopolitics should not be so quickly dismissed. It’s too early to worry that the next crisis is in the offing, but all these issues bear keeping a watchful eye on.


We continue to like carry and credit. We continue to believe that the zero/negative real yields of developed market (DM) government bonds are a reflection of the ongoing distortions created by global central banks. Our favorite investments for the coming three to six months are:

High yield. We like U.S. and European high yield, as well as leveraged loans. Companies continue to enjoy top line growth, cost discipline and accelerating earnings. Our high yield team remarked that this is the first time since the global financial crisis that the market felt normal.

Short-duration securitized credit. Short duration, yield and credit enhancement are an irresistible combination. Further, U.S. consumers are enjoying their strongest balance sheets in over 40 years.

Emerging market (EM) debt. Emerging markets are the one market/sector that has gone through a painful correction. The market looks to have fully priced in potential trade wars and a strong dollar. It’s time to scale in.


This is the quarter we have all been waiting for: QE becomes QT, U.S. fiscal stimulus accelerates, Treasury supply mushrooms, Brexit is a reality, and trade wars loom. There will be increased volatility. There will be markets that become overbought or oversold. Our high yield team is right—for the first time since the financial crisis, things are starting to look normal. Let’s remember what that looks like and take advantage of it in our portfolios!


Every quarter, lead portfolio managers and sector specialists from across J.P. Morgan’s Global Fixed Income, Currency & Commodities platform gather to formulate our consensus view on the near-term course (next three to six months) of the fixed income markets. In daylong discussions, we review the macroeconomic environment and sector-by-sector analyses based on three key research inputs: fundamentals, quantitative valuations and supply and demand technicals (FQTs). The table below summarizes our outlook over a range of potential scenarios, our assessment of the likelihood of each and their broad macro, financial and market implications.

Source: J.P. Morgan Asset Management. Views are as of September 13, 2018.
Opinions, estimates, forecasts, projections and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.

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