As we look toward the remainder of the year, the global economy remains divergent. There is relative strength in the U.S. and Europe, but greater economic uncertainly in Asia. Overall, the probability of global recession is low and as such, the overall macro environment is constructive for investing.
However, much of the “good news” is already priced-in, and many asset classes are fully valued. Moreover, higher volatility is likely. Possible catalysts of higher volatility include the unknown extent of China’s slowdown, geopolitical uncertainty emanating from the Ukraine or the Middle East, and the potential for policy error from central Bankers.
Overall, our investment conclusion is that we want to be cautious in the near term given the potential for higher volatility. However, with a generally supportive macro environment, we are modestly overweight risk assets like high-yield and emerging-market debt and we would use volatility as a buying opportunity.
Outlook on interest rates
Sovereign yields remain at record lows while anxieties about interest rates are at record highs. We believe U.S. Treasury rates will likely remain contained for the foreseeable future because of technical and fundamental factors.
- Supply has declined. With an improving U.S. budget deficit, Treasury issuance is down. Less supply means well supported prices and lower yields.
- The bond market is also supported by still robust demand. Demand is underscored by aging populations, lingering fears of extreme equity volatility, and continued bond buying among central banks and pensions.
Apart from supply and demand, economic fundamentals do not support significantly higher rates.
- Consider GDP: In order to make a case for significantly higher interest rates, one must also make a case for significantly higher GDP. GDP growth is expected to remain modest which is supportive of lower interest rates.
- Next, inflation also remains well contained and in fact too low for areas like Japan and the eurozone. With low inflation, there is little upward pressure on interest rates.
- Finally, we believe there is little risk of rising rates from a credit crisis. Global corporates are very healthy with historically low default rates.
So, in summary, without these technical and fundamental catalysts, rates may stay contained.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917