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Global Bond Outlook Improves After French Election

Published 05/10/2017, 01:15 AM
Updated 05/14/2017, 06:45 AM

As European markets return to fundamentals, Invesco Fixed Income shares its views of rates around the world.

Europe: The risks around the French elections have decreased tremendously following the comfortable Macron victory in the May 7 election. At the same time, data out of Europe continues to be solid and resilient to political risks. Given the French election’s market-friendly outcome, we expect a renewed focus on fundamentals and European Central Bank (ECB) watching going forward. As post-election short covering winds down, we would expect European core yields to resume their upward trend and peripheral spreads versus German bunds to widen again.

US: We are constructive on global growth and believe it will exceed market expectations. Although we expect two more interest rate hikes in 2017, the US Federal Reserve (Fed) has made it clear that it does not intend to tighten policy in a way that disrupts financial markets. Therefore, we expect global growth, and any non-US central bank responses, to be the primary drivers of US rates going forward. In the near term, geopolitical uncertainty is providing support for US Treasuries.

China: The onshore Chinese government bond (CGB) yield curve steepened (long-term rates rose faster than short-term rates) in the first half of April. This was mainly due to selling pressure from bond funds faced with rising redemptions from banks. Banks were forced to reduce their fund investments after China’s bank regulator mandated reduced banking sector, and especially interbank (including non-bank financial institution), leverage. Together with tightened macroprudential rules, we believe this move will likely slow broader credit growth in the second and third quarters, which should negatively impact economic growth momentum in the second half of this year. Therefore, we remain cautious on CGBs in the near term, but bullish in the medium term.

Japan: We do not expect any change in Bank of Japan (BOJ) policy in the near term, despite the fact that inflation continues to underwhelm. If anything, there is increased risk of further downward pressure on inflation going forward as the yen continues to rally and oil struggles to move meaningfully higher. Growth, however, should hold up, with consumers playing a key role. The March services purchasing managers index (PMI) report (highest since August 2015) and March household consumer confidence readings (highest since September 2013) were particularly encouraging in that regard.1

UK: The UK will hold a general election on June 8. We expect this to result in an increased majority for Prime Minister Theresa May, which would likely strengthen her hand in Brexit negotiations. Some commentators have suggested that an increased majority for May could increase the chances of a harder Brexit; however, we believe the opposite is true. The current Conservative Party government has a very small majority in Parliament. As such, the prime minister is dependent on the support of the more extreme members of her government (i.e. those pushing for a hard Brexit). With a significantly increased majority, May would likely be in a position to tone down her demands during Brexit discussions in the knowledge that she could still get parliamentary approval for the final deal without the support of the hardliners in her party. Due to political noise, we expect gilts to underperform both US Treasuries and bunds in the short to medium term.

Canada: The yield on the 10-Year Canadian government bond broke through its recent range of 1.60%-1.87%, reaching a low of 1.43% on April 18.2 Geopolitical risks, as well as concerns about elections in France, were the big drivers as the economic data in Canada have been fairly positive. We expect the Bank of Canada to leave its overnight target rate on hold for an extended period of time as economic data have improved, but slack still exists in the labor market. The positive resolution to the French election should allow yields to move higher from their current levels.

Australia: The Reserve Bank of Australia (RBA) held rates steady in March at 1.50%.3 Its statement noted that global economic conditions have improved recently and headline inflation has moved higher in most countries due to higher commodity prices. The RBA remains concerned about increased borrowing for housing and the country’s stubbornly high unemployment rate. These concerns should keep the RBA on hold for the foreseeable future. We remain neutral on Australian interest rates.

The iShares Core US Aggregate Bond (NYSE:AGG) was trading at $108.44 per share on Tuesday afternoon, down $0.05 (-0.05%). Year-to-date, AGG has gained 0.35%, versus a 7.22% rise in the benchmark S&P 500 index during the same period.

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