The US job market has been one of the brightest spots in a global economic recovery that has otherwise disappointed on many levels. Steady job gains in the US have provided critical fundamental support for financial markets in an environment where growth in many economies is faltering, political and geopolitical event risk is elevated and monetary policy is increasingly disruptive. A reversal of US employment gains would be a game-changer, but we think this is more of a risk for 2017 or later.
- In the near-term, we expect global growth to be slow but steady. The US could accelerate a bit over the next few months and China is likely to be stable, but we think a meaningful pick-up in global growth this year is unlikely.
- Over the longer-term, we think US downside risks are growing. Tight US labor markets are creating wage growth, which could eventually lead companies to cut jobs or accept lower earnings. We think either scenario increases the risk of a US recession over the next year or two. The big unknown is whether higher wages lead consumers to spend more, which could boost corporate revenues and offset some of the effect of higher wages on earnings.
- The headwinds from Brexit are likely to be felt in 2017. The main near-term risk from Brexit has not materialized; markets have been orderly and contagion via the financial channel has been limited. Over the longer-term, however, we think the UK is likely to experience a recession and Eurozone growth is also likely to slow.
- China's credit growth remains more of a long-term risk as well. Credit growth has helped stabilize China’s economy, which has served to reduce capital outflows. But the transmission of credit to the economy appears less and less efficient and we think the resulting financial imbalances create longer-term risks to the sustainability of growth and credit.
- Downside risks put more pressure on policy. The limits—and negative side-effects—of extreme central bank easing measures have become increasingly apparent, leaving monetary policymakers with limited options to address downside risk. Fiscal stimulus is coming in Japan, but we see little scope for meaningful fiscal measures elsewhere.
- In this environment, we think security selection and relative value offer the most opportunity. We see little value, and growing downside risks, in the government and corporate bond markets. We prefer to be below the market-weight in both sectors. In our view, most of the opportunity is in specific emerging market and corporate issuers, the securitized sector and in relative value positioning across different regions and markets.
