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Global Markets Overview – October 2019

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October 23, 2019

In October’s edition of the Global Markets Overview, we track recent price action and our outlook in corporate credit markets.
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In this month’s Global Markets Overview:

  • In this month’s edition, we revisit our corporate credit outlook. Investment grade markets are pricing in an allowance for a below-average level of credit losses. We expect credit losses to be above these levels, with risks skewed to the upside.
  • At current levels, high-quality credit assets are unlikely to provide attractive returns above equivalent government bonds.
  • We also retain a cautious outlook for developed market vanilla speculative-grade credit. Current pricing implies a low level of defaults relative to historic average pricing. We believe risks are skewed toward an increase in defaults, particularly in the U.S. We continue to expect unattractive outcomes for this portion of the credit universe, in absolute terms and relative to niche opportunities within securitized credit.

Monthly overview

  • In the latest round of escalating trade disputes, the Trump administration has announced that it will impose tariffs on $7.5bn worth of Eurozone imports from mid-October, after a WTO ruling found that subsidies given by the EU to Airbus (a European company) were illegal and unfair in its competition to Boeing (an American company). Airbus will face tariffs of 10%, whereas certain EU agricultural and industrial import products will face tariffs of 25%. So far there has been no statement from EU authorities on whether they will retaliate or not.
  • Ongoing trade disputes between the US and China/Eurozone continue to depress the global manufacturing sector. China’s manufacturing sector shrank for two straight quarters and Eurozone PMIs dropped to their lowest levels in 7 years. Germany in particular has been exposed to the global growth slowdown. Manufacturing surveys in the US, Japan and UK have also experienced a similar weakening. Globally, trade tensions are likely to remain a feature of the medium-term political and economic context.
  • The Reserve Bank of Australia (RBA) announced another rate cut of 25bps in its latest monetary policy meeting, taking its policy rate to 0.75%. The RBA is confident this round of monetary policy stimulus, combined with recent tax cuts, infrastructure spending and support to the resources sector should be sufficient to support economic recovery. The main economic risk remains high household debt levels, which diminish the ability of low interest rates to stimulate demand and introduce a downside skew to economic risks.

Our Five-Year Outlook

A summary of our updated Five-Year Outlook is provided below:

  • First, over the next two years, we continue to forecast that the Eurozone, UK and Japan have the highest risk of recession. However, for the US we think monetary easing so far has been enough to stabilize economic growth at average levels. Over five years, our outlook of downside risk being greater than upside risk is unchanged.
  • Second, developed world central banks started the year with relatively limited firepower via their monetary policy to offset any shocks that arise – this situation has worsened given the easing of financial conditions this year, especially the significant fall in US bond yields.
  • Third, relative to our medium-term outlook, we believe valuations for growth-related assets are still high and expect low returns on average over five years, which would put pressure on savers’ wider financial positions.
  • Finally, achieving investment return targets – and hence meeting savers’ expectations – is expected to be difficult in this environment.

Five portfolio priorities for a surprise-free 2019/2020:

  1. Diversify
  2. Reduce unrewarded risks
  3. Macro & dynamism
  4. Innovate through alpha
  5. Innovate to find diversity, e.g., China now offers a new and diversifying set of assets for investors
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