Quarterly macro and market insights from Capital Group’s fixed income team

 

The statements expressed represent perspectives from Capital Fixed Income Investors, as of 30 September 2020. The views of individual portfolio managers and analysts may differ. © 2020 Capital Group. All rights reserved. Data as of 30 September 2020, unless otherwise stated, and attributed to Capital Group / Bloomberg Index Services Ltd.

 

Global backdrop stabilising, but with heightened near-term uncertainty 

The global economy has stabilised sooner than had been anticipated. Unprecedented fiscal and monetary policy responses have helped, though pre-COVID economic levels may still not be recovered for another one to three years. 

The macroeconomic backdrop should be modestly constructive for the next six to 12 months. That said, both the timing and path of recovery include near-term uncertainty. Further accommodative policies and, of course, the trajectory of the virus are major unknowns. While prospects for additional fiscal easing are fluid, easy monetary policy is quite entrenched. 

US industries with revenues totalling US$8 trillion are in recession. The COVID-19-induced recession is having a varied impact. Health care services and hospitals are less affected than the performing arts and sports industries. In contrast, air and ground transportation are being hit hard.

 

The revenue blow from recession-hit sectors could be substantial

 

Sources: Capital Group, Haver Analytics, US Bureau of Economic Analysis. Latest data available as of September 2020. Motor vehicle manufacturing includes bodies, trailer and parts; Other transport manufacturing includes equipment

 

Services related to social consumption are most vulnerable to sustained demand weakness and intensifying pressure to cut capacity. While we don’t expect government lockdowns to return, the virus is likely to have lasting effects on consumer behaviour and consumption. 

Recent inflation volatility reflects both supply and demand shocks. In the near term, deflationary pressures should outweigh the supply shock — leaving inflation unlikely to climb significantly. A more gradual and lengthy US recovery could have a big impact on the supply side, with rising delinquencies and defaults. 

Higher inflation over the long term is a distinct possibility. Supply dislocations, unprecedented growth in money supply (assuming money velocity rises) and significant fiscal spending are likely inflation triggers. In its recent policy framework review, the US Federal Reserve expressed an explicit willingness to tolerate inflation if and when it exceeds 2%. 

European recovery trajectories are diverging. Italy, Spain, France and the UK suffered deep downturns, the result of decreased tourism and leisure services, which are large contributors to their GDPs. Any resurgence of the virus may weigh heavily on these nations’ recovery.

In Germany, manufacturing is a large economic engine; its economy has, therefore, undergone a smaller contraction. Resurgent growth in China — Germany’s largest trading partner — and a manufacturing rebound are boosting prospects. 

The fiscal response in Europe has been surprisingly strong and is widely expected to continue. Crucially, German officials appear to have overcome their long-held aversion to sizable fiscal stimulus. This change of heart could lay the groundwork for fiscal spending (which has already far outstripped levels seen during the global financial crisis) to ramp up further. Among other innovative policies, explicit monetisation of government debt could be on the cards. 

Japan’s economy has taken a significant hit from COVID-19, making the continuation of substantial fiscal support both necessary and likely. For growth and reflation to occur, Japan’s new prime minister, Yoshihide Suga, will also need to continue to lean on his predecessor’s other two policy “arrows”: easy monetary policy and policy reform. Reflation would help support exports by preventing the yen from appreciating too much.

It may be difficult for inflation to rise given excess capacity

 

Sources: Capital Group, Bloomberg, US Bureau of Labor Statistics. Latest data available through August 2020. Resource utilisation uses short-term unemployment. CPI: consumer price index

 

China’s economic activity continues to rebound, led by infrastructure and positive signs in consumer spending. We expect growth to be flat for 2020, with the subsequent trajectory determined by the resilience of the credit impulse. So far, exports have been surprisingly strong, shrugging off weakness in global demand. 

For bond investors, the near-term outlook is highly uncertain at a time when valuations are near long-term averages. These factors suggest an emphasis on higher quality assets is prudent. We also favour selective exposure to higher yielding parts of the market, where return potential adequately compensates for risks entailed and heightened uncertainty in the coming months. 

We are somewhat more optimistic over the medium term given central bank policies and prospects for COVID-19 vaccines and therapies. Volatility in the coming months could also provide attractive entry points for longer term investors who are comfortable taking on more risk.

 

Some scenarios indicate full economic recovery could take years

Sources: Capital Group, Bloomberg, Bureau of Labor Statistics, Haver Analytics, HistStat. GDP: gross domestic product

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.