Recent developments haven’t altered our broadly constructive outlook for the global economy, but we see less cause for optimism. The emerging markets (EM) slowdown is constraining global growth, momentum in the US and Europe is moderating and Japan faces stronger headwinds. The risks of policy missteps in China have manifested, raising the prospect of further volatility. And the benefits of lower oil prices are fading with no end in sight for the ‘lower for longer’ trend in commodities markets. The following themes guide our strategy towards year end:
- The combination of global risks, weak inflation and tighter financial conditions leaves monetary policy heading into year-end more dovish than we envisaged in prior Outlooks. The US Federal Reserve (Fed) may still raise rates this year, but the odds of a delay are growing.
- Inflation has so far proven fairly unresponsive to economic recovery, and even to massive stimulus. We consider the limits of quantitative easing (QE) in the Eurozone and Japan and the implications for these economies and their currencies.
- China’s recent actions related to stocks and the renminbi have contributed to policy uncertainty and the costs in terms of global market volatility are more apparent. We think the broader implications of China’s transition may have been underestimated, but the risk of a sharper downturn hasn’t necessarily increased.
- EM assets have weakened under the combined pressures of the commodities slump, China’s slowdown, dollar strength and fears of US Federal Reserve policy tightening. We differentiate between the highest risk markets and those best placed for a relief rally.
- This backdrop leaves us tactical in rates and moderately constructive on corporate credit. This year’s market retracement makes investment grade credit look more attractive, and we are monitoring risks stemming from the Energy sector downturn in this late-cycle stage.
