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Capital IdeasTM

Investment insights from Capital Group

Categories
Fixed Income
Fixed Income Perspectives
April 28, 2022

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


Insight

The statements expressed represent perspectives from Capital Fixed Income Investors, as at 31 March 2022. The views of individual portfolio managers and analysts may differ. © 2022 Capital Group. All rights reserved. Data as at 31 March 2022, and attributed to Capital Group / Bloomberg Index Services Ltd, unless otherwise stated.

Global growth outlook dims, as uncertainty pressures risk assets

  • US growth may moderate as the war in Ukraine, persistent inflation and tightening US Federal Reserve (Fed) policy take their toll
  • COVID-19 loosened its grip in the US and unemployment dropped, with wages now higher than pre-pandemic levels
  • Risk assets may remain volatile as the market digests upcoming Fed balance sheet tapering

Global economic optimism declined in the first quarter of 2022. War in Europe added to already stiff inflationary headwinds from continued supply chain disruptions. A more hawkish tone from the Fed and other major central banks fuelled concerns of slowing global economic growth. We expect US growth to moderate over the coming quarters.


Market volatility and risk to the downside increased in February as Russian President Vladimir Putin ordered the invasion of Ukraine. Supply disruption intensified worldwide, and commodity prices soared.


The fallout from the war is far from obvious given uncertainty around ceasefire negotiations and how waves of escalating sanctions will play out. Global relations with Russia and China are in flux.


Economic activity appears to have peaked worldwide but remains positive. The US printed a high composite Purchasing Manager’s Index (PMI) in March, signalling continued expansion. The eurozone’s figure eased slightly, while China’s PMI fell.1 US economic activity could continue to outpace Europe as the region will likely bear the brunt of the war’s impact.


US economic activity returned to pre COVID levels as Omicron cases declined. The unemployment rate fell to 3.6% in March.2 That has helped boost wages beyond pre-pandemic levels, though not enough to account for high inflation.


Labour market indicators show workers are in demand

Fixed Income

Data as at 31 March 2022. Source: US Department of Labor

Consumer fundamentals, labour market dynamics and inflation impulses remain strong– setting the stage for tighter Fed policy this year. The US Consumer Price Index (CPI) rose 7.9% year-over-year in February.3 There were broadening price pressures across major categories of the CPI basket including shelter, where prices increased at the fastest pace since May 1991.


Supply issues are likely to remain, with upside risks to food and energy prices due to demand and the war in Ukraine. Investors are pricing rising inflation risk premium into bonds. The five-year breakeven rate on Treasury Inflation Protected Securities (TIPS) jumped 60 basis points (bps) to 3.6% this year, a record high.4


At their March meeting, Fed officials confirmed plans to shrink the balance sheet. Members also leaned into a more aggressive pace of interest rate hikes and the Fed’s dot plot shifted higher. We expect a series of 25-50 bps rate hikes, for a total of 225 bps for the year.


Fed policy rate: Fed dots vs. market

Fixed Income Chart

Data as at 31 March 2022. Source: Bloomberg

The European Central Bank (ECB) and the Bank of England (BoE) both made hawkish pivots over the quarter. The ECB President, Christine Lagarde, flagged “unanimous concern” about inflation but played down the chances of a rate hike in 2022. Meanwhile, in February, the BoE delivered its third 25 bps rate hike in as many meetings.


Inflation has hit almost every sector of the economy

Fixed Income

Month-end data through 28 February 2022. Source: Bloomberg

China stepped up investments in infrastructure to boost anemic growth,with a budget that appears to be mildly stimulative. We forecast growth between 0-2% this year based on the government’s budget allocation and continued low credit growth. The country’s zero-COVID policy could add to economic pain.


Spreads across risk assets widened over the quarteras headwinds to global growth and climbing input costs, reset pricing. With final details on the Fed’s balance sheet tapering not expected until sometime in the second quarter, risk assets could remain volatile.


Forecasts shown for illustrative purposes only.


1. Source: Markit Economics


2. Source: US Bureau of Labor Statistics


3. Source: US Bureau of Labor Statistics


4. Source: Federal Reserve Bank of St. Louis


 

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. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.

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