In the World
Global market performance remained challenged amid lingering volatility. A sharp decline in oil prices dominated headlines, as Brent crude dropped 22% to $60 per barrel, its worst month in over a decade. A confluence of factors drove the decline: an influx of supply from OPEC and U.S. producers, estimates of weaker global demand and waivers on imports from Iran, which further exacerbated supply concerns. While oil was in steep decline, equity markets took a breather from a similar trend in the previous month, though volatility remained elevated. Idiosyncratic risks weighed on select names in the technology sector like Facebook and Amazon, but broader equity markets managed to climb out of the red toward the end of the month, with the S&P 500 finishing 1.8% higher. Stocks reacted positively to an apparent trade truce between the U.S. and China at the G20 summit, as well as comments from Federal Reserve Chairman Jerome Powell that markets look to be “dovish”; both truces helped push U.S. interest rates lower. Meanwhile, global credit spreads widened across the board, and in a reversal of recent trends, higher-quality corporate bonds generally outperformed their lower-quality counterparts.
Concerns about softer growth, coupled with comments from the Fed, tempered market expectations for the path of future rate hikes. Higher jobless claims and a slip in core PCE (the Fed’s preferred inflation measure) in October raised some concern that the U.S. economy might be losing growth momentum. Signs of weakness in the housing market continued to garner attention as well: New and existing home sales softened, and home price growth slowed as mortgage rates have increased nearly a percentage point this year to just north of 5% – an eight-year high. Outside of the U.S., the eurozone continued to see notable softness in economic data: Italy’s economy contracted in the third quarter and the Eurozone Composite Purchasing Managers’ Index (PMI) fell to 52.4 – its lowest reading since mid-2016 – though it remained firmly in expansionary territory. With a backdrop of weakening growth and continued market volatility, a speech by Fed Chairman Powell late in the month drew much attention; his comment that the current policy rate is “just below” the broad range of estimates of the neutral interest rate (in contrast to his comment in early October that it is “a long way from neutral”) was perceived by the market as dovish. While a rate hike in December was still widely anticipated, market expectations for rate hikes in 2019 shifted lower to just one (versus the Fed’s most recent median expectation of three).
An assortment of geopolitical developments continued to capture attention in November. In the U.S., the midterm elections played out largely as expected, resulting in a split Congress; Democrats gained a majority in the House of Representatives, while Republicans maintained a majority in the Senate. Meanwhile in the U.K., Brexit negotiations initially appeared to make headway when Prime Minister Theresa May agreed to a deal with EU officials. However, the agreement triggered a wave of high-profile resignations at home, casting doubt on any progress. In the eurozone, the tone was tense as the EU formally rejected Italy’s budget plan for the second time. Mounting trade tensions between the world’s two largest economies added to the turbulence: President Donald Trump and President Xi Jinping headed into the highly anticipated G20 summit in Argentina at the end of the month with Trump indicating a deal with China was “highly unlikely” just days before the meeting. However, the two leaders agreed on a 90-day truce, and the U.S. postponed a scheduled tariff increase on $200 billion worth of Chinese goods (from 10% to 25%) that was set to take effect January 1.
In the Markets
The underlying strength of fundamentals helped stabilize global equities in November, driving an increase in developed market stocks1 by over 1.1%. In the U.S.,2 stocks rose 2.0% supported by dovish commentary from Fed Chairman Powell, strong consumption data, and signs of an improvement in the outlook for trade tensions. In Europe equities3 declined 0.9% as political tensions, particularly related to Brexit, kept investors cautious while Japanese equities4 rose 2.0% following increasing optimism for the outlook in global trade.
Overall, emerging markets5 stocks increased 4.1% over the month, outperforming developed markets as emerging markets currencies and equities cheered the potential for positive U.S.-China trade developments and a less-hawkish Fed policy. In Brazil6, stocks lagged broader EM equities, rising only 2.4%, as a sharp drop in oil prices weighed on investors. Chinese7 equities fell 0.5% due to ongoing caution and lingering fears related to U.S. tariffs and slowing domestic growth. Indian8 stocks rose 5.2%, outperforming the broader EM complex and benefitting from the drop in oil prices. Russian9 stocks rose 1.7% as positive earnings revisions helped stabilize local equities amid the decline in global energy markets.
DEVELOPED MARKET DEBT
Developed market yields broadly rose to start the month, but reversed course as risk sentiment waned and equity volatility rose. In the U.S., the 10-year Treasury yield peaked at a seven-year high of 3.24% early in the month before falling below 3%; in addition to the swing in overall risk sentiment, some economic data softened, including in U.S. housing and business investment. Dovish interpretations of comments by Fed officials – including Fed Chairman Powell’s remark that the policy rate was “just below” neutral – further contributed to the decline in the 10-year yield, which ended the month 16 basis points (bps) lower at 2.99%. In the eurozone, the German 10-year bund yield fell seven bps by month-end to 0.31%. Negative risk sentiment, along with Brexit developments, also weighed on 10-year U.K. yields, which fell seven bps to 1.36%.
Global inflation-linked bond (ILB) markets posted mixed absolute returns across countries while generally underperforming comparable nominal sovereigns as global inflation expectations fell. Waning risk sentiment during the month, extended weakness in crude prices, and volatility in equity markets all contributed to the drop. U.S. Treasury Inflation Protected Securities (TIPS) returned 0.48%, as represented by the Bloomberg Barclays U.S. TIPS Index. Real yield moves were mixed across the curve, lagging the safe-haven rally in nominal rates. U.S. breakevens fell to their lowest levels in 2018, with the curve steepening due to sagging energy prices. Outside the U.S., the U.K. real yield curve also steepened, as front-end rates rallied on continued uncertainty surrounding Brexit. U.K. breakevens moved higher, supported by the weaker British pound.
Global investment grade (IG) credit10 spreads widened 16 bps in November, and the sector returned ‒0.21%, underperforming like-duration global government bonds by ‒1.74%. A confluence of factors caused spreads to widen, including higher-risk premiums for the U.K. and Italy. Additionally, a series of issuer-specific concerns around downgrades of BBB-rated debt to below-investment-grade affected the credit markets.
Global high yield bond11 spreads widened 53 bps during the month, driven by global trade concerns, lackluster global growth, and the decline in oil prices. Global high yield returned ‒1.16% for the month, underperforming like-duration Treasuries by ‒1.79%. In November, higher-quality issues outperformed lower-quality issues in a reversal of the trend for the first three quarters of 2018: Bonds rated CCC and lower returned ‒3.20% compared to ‒0.48% for the BB segment.
EMERGING MARKET DEBT
Returns on emerging market (EM) debt were mixed across sub-sectors in November. Despite a general tightening of underlying U.S. Treasury yields, external debt posted modestly negative returns of ‒0.39%,12 and spreads widened. Local debt, on the other hand, turned in a robust performance of 2.81%13 as EM currencies strengthened against the U.S. dollar: Dovish comments by Fed Chairman Powell and Vice Chairman Richard Clarida, along with positive headlines on the expected U.S.-China talks at the G20 summit, helped boost EM currencies. Turkey was a notable outperformer in local debt, benefitting from falling inflation and a current account surplus for the second month in a row.
Agency MBS14 returned 0.90% and performed in line with like-duration Treasuries. Mortgages started the month with a move wider as rates moved higher. However, dovish comments from Fed Vice Chair Clarida and Chairman Powell later in the month caused rates to rally and MBS to recover their earlier losses. It is important to note that although performance was in line with like-duration Treasuries, Agency MBS OAS finished the month wider; still, the carry in mortgages was enough to offset the spread underperformance. Higher coupons outperformed their lower coupon counterparts; Ginnie Mae MBS marginally underperformed conventional MBS; and 15-year MBS outperformed 30-year MBS. Gross MBS issuance was the same as in October, while prepayment speeds increased by 9%. Non-agency residential MBS underperformed like-duration Treasuries during November, while non-agency commercial MBS15 returned 0.53%, underperforming like-duration Treasuries by 37 bps.
The Bloomberg Barclays Municipal Bond Index posted a return of 1.11% in November, bringing year-to-date returns to 0.08%. Munis outperformed the U.S. Treasury Index over the month on a duration- and quality-matched basis. High yield munis returned 0.70%, primarily driven by positive returns in the water and sewer and leasing sectors, bringing the year-to-date return to 3.86%. November muni supply of $27 billion was down 26% versus the previous month and down 40% year-over-year, primarily due to the impact of tax reform. Muni fund flows were negative in November, and aggregate outflows totaled $5.4 billion for the month.
Performance of the U.S. dollar was mixed versus other G10 currencies, against the backdrop of dovish Fed comments and moderating economic data. The British pound finished the month roughly unchanged, as optimism over a potential Brexit deal was tempered by a rash of cabinet resignations and an uncertain outlook for the deal in Parliament. The euro, aided by the expectation for a more dovish Fed, remained nearly unchanged against the dollar despite softening economic data and more headlines on the Italy-EU budget dispute. Notable G10 outperformers Australia and New Zealand benefited from stronger-than-expected labor market data and improving sentiment toward U.S.-China trade discussions.
In energy, oil declined the most since 2008 as uncertainty about demand and increased production both weighed on prices. Record output from Saudi Arabia, Russia and most notably the U.S. more than offset declines from Iran and Venezuela. The U.S. Energy Information Administration (EIA) reported that October crude oil production in the U.S. averaged 11.4 million bbl/d ‒ 400,000 bbl/d higher than previously forecast. An early season cold snap amid lean inventories caused natural gas prices to surge more than 40% in November, with prices reaching $4.8/mmbtu for the first time since 2014. The agricultural sector posted positive returns. Wheat prices gained on planting delays, and soybeans rose on improving trade sentiment. The U.S. Department of Agriculture’s (USDA) forecast for lower-than-expected yields supported corn prices. Base metals also delivered positive returns. Copper prices rose amid favorable fundamentals: Falling inventories available on metals exchanges and higher-than-expected imports from China suggested strong demand for the red metal. Expectations for increased supply due to new capacity in Indonesia weighed on nickel prices. Precious metals were largely flat for the month.
Based on PIMCO’s cyclical outlook from December 2018.
In the U.S., after an expansion of close to 3% in 2018, we look for growth to slow to a below-consensus 2.0%–2.5% range in 2019. The drop reflects the recent tightening of financial conditions, fading fiscal stimulus and slower growth in China and elsewhere. Growth momentum is likely to moderate during the year converging to trend growth of just below 2% in the second half. Headline inflation looks set to drop sharply over the next several months, reflecting base effects and the recent plunge in oil prices, while core CPI of about 2% is expected to trend sideways. Following an expected December rate hike to a range of 2.25%−2.5%, we expect one or two more increases in the fed funds rate by year-end 2019, with a high chance of the Federal Reserve pausing or even ending the hiking cycle in the first half.
For the eurozone, we expect growth to slow to a below-consensus 1.0%–1.5% in 2019 from close to 2% in 2018. Our downward revision from our outlook in September reflects the tightening in financial conditions in Italy as well as weaker global growth. We think core consumer price inflation will pick up somewhat in 2019 from 1% as unemployment is likely to keep falling and wage growth has accelerated. Yet, it should still fall under the “below but close to 2%” objective. We expect the European Central Bank (ECB) to end net asset purchases by the end of 2018 and raise rates once in the second half of 2019, although if the Fed pauses and the euro appreciates versus the U.S. dollar, the ECB may leave rates unchanged until 2020.
In the U.K., we expect real growth in the range of 1.25%–1.75% in 2019 based on our expectation that a chaotic no-deal Brexit will be avoided. Our below-consensus inflation forecast calls for inflation to come back to the 2% target over 2019 as import price pressures fade and weak wage growth keeps service sector inflation subdued. We see one or two rate hikes from the Bank of England over the next year.
Japan’s GDP growth is expected to be moderate at 0.75%–1.25% in 2019, supported by a tight labor market and a supportive fiscal stance. With inflation expectations low and improving labor productivity keeping unit wage costs in check despite wage growth, core inflation is likely to creep up only slightly to 0.5%‒1.0%, well below the 2% target. While we don’t expect the Bank of Japan (BOJ) to raise interest rates, we anticipate further tapering of bond purchases and further steepening of the yield curve as the BOJ tweaks its buying operations.
In China, we expect 2019 growth to slow to the middle of a 5.5%‒6.5% range that reflects large uncertainties caused by trade tensions with the U.S., domestic pressure to deleverage, and an economic policy with partially conflicting targets (growth and unemployment versus financial stability). We project a moderate rebound in CPI inflation to 2.0%‒3.0% on rising energy and food prices and expect the People’s Bank of China to cut reserve requirements further rather than cut rates. We also expect a fiscal expansion worth about 1.5% of GDP, focused mainly on tax cuts for corporates and households. Any further depreciation of the yuan against the dollar is likely to be moderate unless trade negotiations between the U.S. and China fail and tensions escalate.