Knowledge. Shared Blog

December 2019

Market GPS: Outlook for Bond Markets Hinges on Trajectory of Global Economy

Heading into the new year, a key question is whether the global economic slowdown has hit bottom and if we should expect growth to reaccelerate. Co-Heads of Strategic Fixed Income Jenna Barnard and John Pattullo discuss how the answer to that question could impact fixed income performance in 2020.

Key Takeaways

  • Contrary to the consensus view in 2019, we expected that bond yields would remain low for the foreseeable future. We have now seen consensus come back to our view as central banks globally return to easing mode.
  • Looking ahead, some indicators suggest the global economic slowdown could be nearing its end. If growth and inflation pick up again in 2020, bond markets could struggle.
  • In our view, the strength of the dollar could be key to determining whether – and by how much – the global economy accelerates going forward.
View Transcript Expand

Jenna Barnard: Well, when you think about the opportunities and risks with bonds, what you need to understand is they are a relatively simple asset class. Government bond yields and interest rates follow the rate of change in growth and inflation. So, in the last 12 months, bonds have done a great job diversifying portfolios and equity risk. And as growth peaked and inflation peaked, bond yields peaked around the world.

So, going forward from here into 2020, the question is now whether we are bottoming out in terms of the decline in economic growth and inflation. So, that is a debate that’s been happening since September. There are initial signs that the manufacturing cycle may be bottoming and that the rate of change in growth and inflation may begin to pick up, in which case bonds will have a tough time, as you would expect. As I said, they’re a simple asset class, and they diversify a portfolio because they react to the rate of change in economic growth and inflation.

We actually had a nonconsensual view on bond yields and interest rates. We thought they would stay low for a very long period of time. We never agreed with the consensus that bond yields and bond markets were a bubble. And 2019 has confirmed that. If anything, consensus has come around to our view. You’ve heard “Japanification” talked about ad infinitum, and central banks globally have also begun to shift their reaction function. So, they’re now saying the biggest challenge is that inflation is too low and has been too low since 2009. You heard that from the Federal Reserve in the U.S., particularly. Very different to 18 months ago when they thought inflation taking off would be the biggest challenge. But it is interesting that consensus has now come around to our view of the world.

John Pattullo: The irony is we spend our life looking at endless charts, and what we do do [is] a lot of work and see if there is confirmation between different charts, between different asset classes, whether they corroborate existing views and evidence or contradict because sometimes they can obviously contradict. But I guess the main one in my mind is, really, the strength of the dollar. There’s obviously significant debate about whether we’re in a soft landing and it’s mid-cycle or whether we’re in a hard landing and it’s late cycle. The first case is more [an] equity view of the world and the second case is more the bond view of the world.

What I think can be said, and this is the tell, if you like, it’s unlikely to get a significant soft landing and a reflation unless you have a soft dollar. That’s a pretty important point. Against that we look at endless charts, of which many are important. But I think the important ones are oil, a general proxy for demand, [the] shape of the yield curve – of course we do, we’re bond people – and money supply growth, I think, are probably the most topical ones – and financial conditions. I could give you a hundred more, to be honest. But really, the dollar is the tell, and that’s the one which I think, in my opinion, is really significant.

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