Emerging markets are unlikely to repeat the stellar 2016 performance they’ve experienced at the time of writing, but we expect a year of low to middle single-digit returns. Given that emerging market assets are largely dependent on the global environment, we believe that sustained central bank accommodation, relatively stable, if subdued, growth and still-moderate inflation provides a favorable backdrop for emerging market assets.
Additionally, investors’ ongoing reach for yield, their preference for income and emerging markets’ continued attractiveness versus developed markets suggest the momentum behind flows into assets will likely continue. Discernment in outlook is a key theme for emerging market countries. Now, as always, we focus on countries and credits with a variety of perceived catalysts (credible, active central banks, fiscal responsibility, etc). The main risks to our relatively sanguine view are a significant sell-off in US Treasury yields, unanticipated central bank policy shifts, significantly slower global growth or a sharp acceleration in US dollar strength.
European fixed income
European fixed income in 2017 will continue to be challenged by macroeconomic headwinds coupled with a number of elections that are scheduled across the region. The rise of anti-establishment parties, primarily linked to the poor sustained economic performance over past years, will mean we are likely to face another year scattered with bouts of heightened volatility.
The European Central Bank (ECB) has enjoyed some success from monetary policy actions, with reduced fragmentation, but bank lending remains lacklustre and we expect Brexit to be a drag on European growth. However, Europe remains in the early stages of the economic cycle, and we expect the ECB’s quantitative easing (QE) program to be extended beyond March 2017 as inflation continues to disappoint and growth stays low. Hence, we expect future opportunities will likely arise from domestic political events and/or central bank action. Moreover, we are neutral in the periphery and remain cautious on the outlook of Italy and Portugal, which is tempered by seeing value in Irish and Spanish bonds.
Global high yield
We expect US high yield to perform well in 2017. Most corporate revenue in the US high yield market is tied to the health of the US consumer, which, we believe, will likely remain stable in 2017. The outlook for corporate revenue and profitability outside the US is more idiosyncratic and dependent on the country/region. Actions by the US Federal Reserve could have an important impact on global high yield sentiment and the US dollar, which could lead to volatility in commodity prices and commodity-related high yield assets. Weaker Chinese demand could also weigh on global high yield, as could disappointing growth outcomes in Europe. However, we are constructive on a number of developments in the US high yield market: many US high yield companies have navigated the commodity price downturn successfully by cutting costs and improving balance sheets, debt-financed mergers and acquisition activity has been fairly muted, and default levels have ticked up only slightly. These developments are all likely to be supportive for US high yield bonds in 2017.
Global investment grade
We anticipate global investment grade credit will outperform sovereign counterparts in 2017 due to the favorable macroeconomic backdrop and continued market demand for yield. The expectation of a global recession remains low as liquidity, particularly outside the US, remains high. In the US, although rhetoric from the US Federal Reserve (Fed) is expected to target higher interest rates, we expect tightening to be limited. Additionally, the ECB and Bank of England are expected to continue their quantitative easing efforts. The inclusion of corporate debt in their purchase programs further restricts the supply of yield-based assets available to investors and potentially supports global investment grade bonds.
The risks to our views include an unexpected deceleration in global growth, which could pressure credit fundamentals and risky assets. Alternatively, an acceleration in global growth and inflation could lead to higher interest rates, which could be particularly challenging for sovereign bonds given the limited protection provided by their very low yields. As we enter 2017, performance of corporate credit may depend largely on avoiding problem sectors and issuers and capitalising on opportunities as they arise.
The year ahead should allow US money market fund managers to resume focus on adding value in a post-reform word. Sufficient supply of US government securities should keep a floor under short-term interest rates; however, we will be watching potential developments around the US debt ceiling in early 2017, which could affect the supply of US Treasury securities in the short run. A slow-growing US economy will likely keep the focus on the Fed in 2017, but similar to recent years, forward guidance and a gradual approach to rate hikes with the least amount of disruption is likely the Fed’s preferred path. Money market reform in Europe should start to take shape in 2017, but with a long path to implementation (similar to the US), the impact on markets might not be evident until 2018.