Global Macroeconomic & Market Outlook The T emperature is Rising Neil Michael Chief Investment Strategist July 2018 Private & Confidential Crown Agents Macroeconomic & Market Outlook
Table of Contents Trade Tensions European Political Uncertainty Global Labour Markets Global Product Markets Inflation The Yield Curve Market Outlook Summary of House View Private & Confidential Crown Agents Macroeconomic & Market Outlook 1
Macro Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook
Trade Tensions Are Heating Up Actual and Proposed New Tariffs Source: CAIM. Private & Confidential Crown Agents Macroeconomic & Market Outlook 3
New Tariffs Are A Small % GDP But Could Become Non-Trivial Tariff Announcement & US/China Imports Tariff Announcement % of US/China GDP Source: CAIM. Private & Confidential Crown Agents Macroeconomic & Market Outlook 4
Average Tariffs Unlikely To Rise To 1930s Levels Change in World GDP (%) US Average Tariff Rates (1821 – 2016) Source: Barclays Capital. Private & Confidential Crown Agents Macroeconomic & Market Outlook 5
World Trade Is Slowing Down With Implications For Industrial Production & Tariffs Could Exacerbate Inflation World Trade & Industrial Production Impact on US of $200 Billion Tariffs Source: Bloomberg. Data from December 2010 to April 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 6
European Political Uncertainty Is Heating Up - Quitaly!? Italy & Euro 10Yr Gov Bond Yields Holdings Of Italian Gov Bonds % Total Source: Bloomberg. Data from July 2010 to July 2018. Source: Bruegel. Data from 1997Q1 to 2017Q4. Private & Confidential Crown Agents Macroeconomic & Market Outlook 7
European Political Uncertainty Is Heating Up – Brexit – A New Model Brexit Models EU27 Exports To UK Private & Confidential Crown Agents Macroeconomic & Market Outlook 8
Global Labour Markets Are Heating Up Global Wage Rates (%YoY) Global Unemployment Rates (%) Source: Bloomberg. Data from September 2002 to May/June 2018. Source: Bloomberg. Data from March 2007 to April/May 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 9
Global Product Markets Are Heating Up – Positive Output Gaps Advanced Economies Output Gap Global Output Gaps Source: Bloomberg; IMF. Data from January 1980 to December 2019. Source: Bloomberg. IMF. Private & Confidential Crown Agents Macroeconomic & Market Outlook 10
Developed Economies Hotter Than Emerging Economies Developed & Emerging Economies Composite PMIs Source: Bloomberg. Data from July 2015 to June 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 11
Rebounding Services Making Up For Softer Manufacturing DM & EM Manufacturing PMIs DM & EM Services PMIs Source: Bloomberg. Data from July 2015 to June 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 12
The Pause That Rebalances – Weaker Euro Should Help Eurozone Catch-Up With US US-Eurozone PMIs Vs US-Eurozone 10Yr US-Eurozone PMIs Vs USDEUR Exchange Rate Government Bond Yield Source: Bloomberg. Data from July 2015 to June 2018. Source: Bloomberg. Data from July 2015 to June 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 13
US Fiscal Stimulus Amid Full Employment Raises Overheating Risk US Fiscal Balance & Unemployment Private & Confidential Crown Agents Macroeconomic & Market Outlook 14
Inflation Is Getting Hotter Global Headline Inflation Rates (%) Global Core Inflation Rates (%) Source: Bloomberg. Data from December 2000 to May 2018. Source: Bloomberg. Data from December 2000 to May 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 15
The Yield Curve Is Flattening FOMC Fed Funds Rate Expectations US Yield Curve (10Yr-2Yr), GDP & Oil Price Source: Bloomberg. Data from Dec 1990 to Apr/Dec 2018 (Est). Source: Bloomberg. Data from Jan 1990 to Mar 2018/Dec 2018 (Est). Private & Confidential Crown Agents Macroeconomic & Market Outlook 16
Yield Curve Might Not Invert If Natural Growth Rate and R* Rises US Natural Growth Rate & 10Yr Trends In US Factors Of Production Government Bond Yield Source: Bloomberg. Data from December 1971 to December 2020 (Est) Source: Bloomberg. Data from December 1971 to December 2020 (Est) Private & Confidential Crown Agents Macroeconomic & Market Outlook 17
Market Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook
Market Performance – Riskiest Markets Have Outperformed YTD Market Performance % Year-to-Date Market Performance % Source: Bloomberg. Data to 29 June 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 19
Government Bonds - Inflation & Growth Pushing Up Bond Yields Weighted Ave 2Yr Govt Bond Yield & PMIs Weighted Ave 2Yr Govt Bond Yield & Inflation Source: Bloomberg. Data to June 2018. Note: Ave = GDP weighted Average of US, UK, Eurozone, Japan & Canada Private & Confidential Crown Agents Macroeconomic & Market Outlook 20
Government Bonds – US Offers the Best Carry & Compensation for Inflation in the Developed World Government Bond Yields 2Yr % Government Bond Yields 10Yr % Source: Bloomberg, Data from 12 Jan 2001 to 6 July 2018. Private & Confidential Crown Agents Macroeconomic & Market Outlook 21
Bond Yields & Inflation/PMIs – US & Canada Bond Yields Have Adjusted the Most to Economic Reality 2Yr Government Bond Yield vs. Headline Inflation & Composite PMIs Private & Confidential Crown Agents Macroeconomic & Market Outlook 22 Source: Bloomberg, Data to May/June 18.
Central Bank Rates – US Expected To Increase Rates the Most In 2018 But Will Be Overtaken By UK & Eurozone in 2020 Expected Change in Central Bank Rates Source: Bloomberg. Consensus of Economists Surveyed. Private & Confidential Crown Agents Macroeconomic & Market Outlook 23
Sharp Increase in Supply of Treasuries Could Push Up Bond Yields Private & Confidential Crown Agents Macroeconomic & Market Outlook 24
Duration Management Strategy – Positive Alpha Over Time Performance of Duration Management Strategy US 5Yr Gov Bond Yield Econometric Model vs 3-5Yr Gov Bond Index Source: Bloomberg. Data from Dec 1998 to June 2018. Note: Based on regression (line of best fit) of 5Yr Govt Bond Yield on Equity Index, IG Bond Index, HY Bond Index, EM Bond Index, 2Yr Govt Bond Yield, Oil Price, Currency and PMI. Strategy: If spread below 1SD then 1-3Yr; if spread above 1SD then 5-7Yr; otherwise 3-5Yr Index. Private & Confidential Crown Agents Macroeconomic & Market Outlook 25
Econometric Model of 2 Year Government Bond Yields – UK & Canada Relatively Undervalued; Eurozone Relatively Overvalued Number of Standard Deviations Above/Below Equilibrium Yield Source: Bloomberg. Dec 1998 to June 2018. Note: Based on regression (line of best fit) of 2Yr Govt Bond Yield on Equity Index, IG Bond Index, HY Bond Index, EM Bond Index, 10Yr Govt Bond Yield, Oil Price, Currency and PMI Private & Confidential Crown Agents Macroeconomic & Market Outlook 26
Quasi Government Bonds – Tight Spreads But Starting To Widen US 1-3Y Quasi Government Bond Spread US 7-10Yr Quasi Government Bond Spread Source: Bloomberg, Bank of America Merrill Lynch US Foreign Government & Supranational Indices. Data from 12 Jan 2001 to 6 July 2018 Private & Confidential Crown Agents Macroeconomic & Market Outlook 27
Emerging Market Bonds – Spreads Have Blown Out & External Vulnerabilities Have Increased EM 10 Yr Gov Bond Yield vs US 10 Yr Gov Bond Yield Emerging Markets Current Accounts & External Debt Source: Bloomberg. Data from Jan 2001 to 6 July 2018. Source: Bloomberg. Private & Confidential Crown Agents Macroeconomic & Market Outlook 28
2Yr Investment Grade Corporate Bonds – Tight Spreads But Starting To Widen US 2Yr IG Corp Spread UK 2Yr IG Corp Spread Source: Bloomberg, Bank of America Merrill Lynch. Data from 12 Jan 2001 to 6 July 2018 Private & Confidential Crown Agents Macroeconomic & Market Outlook 29
10Yr Investment Grade Corporate Bond – Widening Spreads US 10 Yr IG Corp Spread UK 10Yr IG Corp Spread Source: Bloomberg, Bank of America Merrill Lynch. Data from 12 Jan 2001 to 6 July 2018 Private & Confidential Crown Agents Macroeconomic & Market Outlook 30
IG Corporate Bond – Leverage is Higher & Quality Lower US IG Corp Leverage US IG Corp Credit Quality Source: JP Morgan. Source: HSBC. Private & Confidential Crown Agents Macroeconomic & Market Outlook 31
High Yield Corporate Bond – Tight Spreads US HY Corp Spread UK HY Corp Spread Source: Bloomberg, Bank of America Merrill Lynch. Data from 12 Jan 2001 to 6 July 2018 Private & Confidential Crown Agents Macroeconomic & Market Outlook 32
HY Corporate Bond – Default Rates Low But Rising & Leverage Lower Than Before Crisis US HY Corp Default Rate US HY Corp Leverage Private & Confidential Crown Agents Macroeconomic & Market Outlook 33
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