Highlights from last month

Domestic policy adjustments in vulnerable emerging market (EM) economies and some reprieve in global trade frictions helped bolster investor sentiment for much of September. After a tumultuous August, some EM countries responded with policy adjustments: Turkey’s central bank hiked its policy rate by 6.25 percentage points to 24%, more than markets expected and despite President Recep Tayyip Erdoğan’s ostensible opposition. Additionally, the Turkish government came out with a medium-term fiscal framework to rebalance the economy, including lower growth and spending targets. Argentina renegotiated its IMF program to $57 billion – an increase of $7 billion – along with an acceleration of disbursements, indicating sufficient financing through the end of 2019. Meanwhile, trade concerns appeared to ease somewhat as U.S. and Canadian negotiators struck a new NAFTA deal at the eleventh hour and the additional tariffs on $200 billion of Chinese goods announced by the U.S. were set at only 10% – less than the expected 25%. However, the lower tariffs weren’t enough to stem the tensions between the two countries: China retaliated with tariffs on $60 billion worth of goods, provoking threats by President Donald Trump to impose additional tariffs. Meanwhile, Italy’s government increased its budget deficit target for 2019 in a highly contentious, late-night cabinet meeting in Rome, rekindling worries about the country’s fiscal condition and weighing on European markets.

Major central banks continued to shift toward decreased accommodation. In the U.S., the Federal Reserve raised its policy rate another 25 basis points, marking the third rate increase this year and the eighth since its hiking cycle began in late 2015. The rate-setting committee also increased its growth projections for 2019 and released its latest “dot plot,” which provided expectations for one more hike in 2018 and three in 2019. Emblematic of the less supportive policy, the committee also removed the word “accommodative” from its official statement, erasing a key accessory of the bank’s forward guidance in the postcrisis era. The relatively upbeat picture in the U.S. contrasted with slower growth expectations in Europe, as the European Central Bank (ECB) reduced its forecast for the eurozone economy over the next two years. Despite the reduction, the ECB confirmed its intention to cease bond purchases by year-end and to keep interest rates unchanged for at least another year. Meanwhile, Norway’s central bank increased interest rates for the first time in seven years, becoming the latest in a small club to tighten policy.

Risk assets in the U.S. continued to outpace global peers while the pressure on emerging markets assets moderated somewhat. Amid an 18-year high in consumer confidence and a robust labor market, U.S. stocks advanced 0.6% and clinched a new all-time high (capping a nearly 8% gain in the third quarter). Credit spreads tightened and interest rates – alongside most developed market yields – rose. While U.S. risk assets generally fared well, European and Italian assets in particular came under renewed pressure: Italian government bond yields spiked and equities fell after key officials endorsed a budget that would increase the deficit to 2.4% of GDP. In emerging markets, equities had a rocky start to the month but found their footing, while local currency bonds experienced gains in September, halting their decline earlier in the quarter. In commodity markets, oil closed above $80/barrel for the first time in nearly four years as the market focused on declining Iranian exports. Despite calls from the Trump administration to moderate prices, OPEC and its allies chose not to increase output, fostering concerns around supply. All in all, September featured a break from some recent trends of late, though global trade and geopolitical uncertainties still lingered.

Chart 1

Then and Now
This month marks the 10-year anniversary of Lehman Brothers’ collapse on 15 September 2008, an event that roiled financial markets and sparked the beginning of the Global Financial Crisis. Widespread distress and liquidity issues in the banking sector propelled central banks globally to engage in unprecedented large-scale asset purchases, dubbed “quantitative easing.” The combined balance sheets of the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China expanded from $7 trillion to nearly $20 trillion over the subsequent decade. This liquidity injection, at least in part, underpinned a 10-year rally in equities and interest rates: The S&P 500 index rose 210%, while international equities increased 70%. Meanwhile, developed market yields and credit spreads fell to multidecade, and in some cases, all-time lows.

Market snapshot


Strong fundamentals continued to support developed market stocks1 as they rose 0.6% over the month. In the U.S.2 stocks gained 0.6% thanks to positive earnings momentum and the prospect of normalized U.S. trade relations with Canada and Mexico. Japanese equities3 surged 6.1% as the outlook for Japan-U.S. trade improved and the yen weakened versus the U.S. dollar. European equities4 increased 0.5% due to improving economic data and signs of stabilization in growth.

Overall, emerging market5 stocks fell 0.5% in September, led by weakness in select regions including India and South Africa. As oil prices soared more than 5%, Indian8 stocks fell 6.2% due to concerns over rising inflation and a widening trade deficit. Russian9 stocks, however, rallied 6.0% and the ruble gained on the rise in energy prices. In Brazil,6 stocks rose 3.2% after sentiment modestly recovered and raw commodity prices increased over the month. Despite ongoing trade tensions, Chinese7 equities rose 3.7% as indications of supportive domestic policy outweighed concerns of an economic slowdown.


Developed market yields broadly rose in September amid a solid fundamental backdrop and diminished central bank accommodation. In the U.S., the Federal Reserve increased its policy rate for the eighth time this cycle and removed “accommodative” from its policy language. With labor market and growth indicators strong, the U.S 10-year yield ended the month 20 basis points (bps) higher at 3.06%. The European Central Bank (ECB) also signaled a shift toward less accommodation by confirming plans to cease asset purchases by year-end, which contributed to 10-year German bund yields rising 14 bps to 0.47%. In the U.K., an unexpected rise in inflation along with an upside surprise in wages helped push the U.K. government 10-year rate 15 bps higher to 1.57%.


Global inflation-linked bonds (ILBs) posted negative returns across most markets but generally performed in line with comparable nominal sovereign bonds in September. U.S. Treasury Inflation Protected Securities (TIPS) returned ‒1.05%, as represented by the Bloomberg Barclays U.S. TIPS Index. U.S. real yields moved higher across the curve in response to a strong U.S. jobs report and in anticipation of another well-telegraphed quarter-point Fed rate hike on September 26. The U.S. breakeven inflation (BEI) curve flattened over the month on stronger wage data and a rally in crude oil prices. Outside the U.S., U.K. breakevens shot higher at mid-month, driven by a significant upside surprise in August inflation. In Italy, real yields ended the month lower; Fitch maintained the nation’s credit rating early in the month, though rates rose sharply into month-end when the new government released a budget that included a larger-than-expected deficit target of 2.4% for the next three years.


Global investment grade (IG) credit10 spreads tightened 6 bps in September, and the sector returned ‒0.39%, outperforming like-duration global government bonds by 0.54%. Spreads tightened, retracing their path wider in August, thanks to strong demand at higher yields and lower-than-expected M&A issuance; strength in oil and copper markets supported commodity-related sectors.

Global high yield bonds continued to rally in September, driven by record earnings, limited supply, stabilizing fund outflows, and the lowest corporate leverage levels since the financial crisis. Global high yield bonds remained resilient in the face of increasing rates, even as the 10-year U.S. Treasury touched a high of 3.10%. In September, global high yield posted an excess return over like-duration Treasuries of 1.06%, and lower-quality issues, which tend to have lower sensitivity to rates, outperformed higher-quality issues.


Emerging market (EM) debt and all of its subsectors posted positive returns in September. Despite a move higher in the underlying U.S. Treasury yields, tightening spreads drove positive returns in external debt. On the local side, positive performance was driven by a rebound in EM currencies. The general reprieve for EM assets in September was driven by positive developments in Argentina, which renegotiated its IMF program to shore up its financing abilities, and Turkey, which substantially tightened monetary policy and released a fiscal plan to rebalance its economy. Consequently, Argentina’s and Turkey’s external debt outperformed the index, as did Turkey’s local debt; Argentina’s local debt underperformed the index as the country moved to a wide crawling band for its currency, which then underperformed.


Agency MBS12 returned ‒0.61% and outperformed like-duration Treasuries by 11 bps during the month. An increase in overseas demand supported the sector while higher Fed balance sheet runoff and elevated market expectations for supply through year-end weighed on MBS performance. Higher coupons (4.5% and 4.0%) outperformed their lower-coupon counterparts (3.5% and 3%); Ginnie Mae MBS outperformed conventional MBS; and 15-year MBS outperformed 30-year MBS. Gross MBS issuance decreased while prepayment speeds increased by 1%. Non-agency residential MBS outperformed like-duration Treasuries during September, and non-agency commercial MBS13 returned ‒0.36%, outperforming like-duration Treasuries by 41 bps.


The Bloomberg Barclays Municipal Bond Index posted a return of ‒0.65% in September, bringing year-to-date returns to ‒0.40%. While munis outperformed the U.S. Treasury Index over the month, on a duration- and quality-matched basis, MMD/UST ratio performance remained relatively unchanged. High yield munis returned ‒0.40%, primarily driven by negative returns in leasing, healthcare and tobacco sectors, bringing the year-to-date return to 4.45%. September supply of $23 billion was down 30% versus the previous month and down 23% year over year, primarily due to the impact of U.S. tax reform. Muni fund flows were negative in September: Aggregate outflows totaled $271 million for the month.


After trending down early in the month, the U.S. dollar finished unchanged against its G10 counterparts following a Fed rate hike and “safe-haven” inflows due to concerns over Italy’s proposed budget. Similarly, the euro ended the month practically unchanged after Italian budget concerns reversed its earlier strength. Emerging market currencies enjoyed a reprieve in September; most notably, the Turkish lira rose more than 8% after the country took steps to address its macroeconomic challenges, including raising rates. The British pound weakened around 0.5% as it appeared that Brexit negotiations had reached an impasse. A combination of trade fears, rising oil prices and continued policy divergence weighed on the Japanese yen, and it weakened more than 2.4% against the dollar.


Commodities delivered positive returns in September. In energy, oil prices extended their climb to a near four-year high amid looming supply concerns. The market continued to focus on the supply impact of the reimposition of U.S. sanctions on Iran. Despite calls from the Trump administration to moderate prices, OPEC chose not to adjust output following its meeting in Algiers. This “wait-and-see” approach provoked speculation over OPEC’s spare capacity. Petroleum products followed crude higher, while natural gas closed above $3/MMBtu. The agricultural sector posted negative returns. Despite record yield projections, soybeans firmed over the month amid weather-related harvest delays and strong exports to Mexico. Corn also rose on rain delays, in addition to strong sales and ethanol production. Wheat prices fell after the U.S. Department of Agriculture forecasted an uptick in Russian production and higher world stockpiles. India’s approval of a large subsidy program weighed on sugar prices. After falling for much of the year, base metals saw some relief when the latest tariffs in the U.S.-China trade conflict were set lower than expected. Precious metal prices were flat, with platinum outperforming gold.

Appendix Table


Based on PIMCO’s cyclical outlook from September 2018.

PIMCO expects world GDP growth to slow somewhat but remain above-trend at 2.75%‒3.25% in 2019. With tighter global financial conditions, increased political and economic uncertainties, and U.S. fiscal stimulus starting to fade in 2019, we think the economic divergence of 2018 – the U.S. accelerating and other regions slowing – will give way to a more synchronized deceleration, with the U.S., the eurozone and China all seeing lower growth than this year. We expect inflation globally to remain essentially unchanged from 2018 at 2.0%‒2.5%.

In the U.S., after an expansion of about 3% in 2018, we look for growth to slow to a below-consensus 2.0%–2.5% range in 2019. The drop reflects less support from fiscal stimulus, the ongoing removal of monetary accommodation, a stronger U.S. dollar and a less favorable trade and external environment. With economic growth still above potential, though, unemployment should decline further toward 3.6%. We expect inflation to peak at around 2.5% in response to tariff increases before moderating somewhat. We forecast three more increases in the fed funds rate by the end of 2019.

For the eurozone, we expect growth in a range of 1.5%‒2.0% over the next year, down significantly from 2.5% in 2017 but still above potential output growth. Recent purchasing managers indexes point to a growing divergence within the eurozone, with Italy falling behind, which bears watching given the government’s anti-euro leanings. Core inflation is expected to pick up to 1.25%‒1.75% from 1% as unemployment keeps falling, wage growth continues rising, and the euro is no longer appreciating. We expect the European Central Bank to end net asset purchases by the end of 2018, and a first rate hike is more likely than not in the second half of 2019.

In the U.K., we expect above-consensus real growth in the range of 1.5%–2.0% in the next year based on our expectation that Brexit negotiations will progress and a hard Brexit will be avoided. This should help domestic demand in 2019. Our below-consensus inflation forecast calls for inflation to fall back to 1.75%‒2.25%, slipping below the 2% target over the next year as import price pressures fade and weak wage growth keeps service sector inflation subdued. We forecast two more rate hikes from the Bank of England over the next year.

Japan’s GDP growth is expected to remain steady at 1.0%–1.5% in 2019, supported by a tight labor market and accommodative fiscal stance. With inflation expectations low and improving labor productivity keeping unit wage costs in check, 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 to raise interest rates, we anticipate further tapering of bond purchases and further steepening of the yield curve.

In China, we expect 2019 growth roughly in the middle of a 5.5%‒6.5% range that reflects large uncertainties caused by trade tensions with the U.S. and an economic policy with partially conflicting targets (growth and unemployment versus financial stability and deleveraging). Our baseline assumes only the recently announced tariff increases and fiscal expansion worth about 1% of GDP. 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 keep interest rates and reserve ratios unchanged. We expect only moderate depreciation of the yuan against the dollar, barring a full trade-war scenario.


1MSCI World Index, 2S&P 500 Index, 3Nikkei 225 Index (NKY Index), 4MSCI Europe Index (MSDEE15N INDEX), 5MSCI Emerging Markets Index Daily Net TR, 6IBOVESPA Index (IBOV Index), 7Shanghai Composite Index (SHCOMP Index), 8S&P BSE SENSEX Index (SENSEX Index), 9MICEX Index (INDEXCF Index), 10Barclays Global Aggregate Credit USD Hedged Index, 11BofA Merrill Lynch Developed Markets High Yield Index, Constrained, 12Barclays Fixed Rate MBS Index (Total Return, Unhedged), 13Barclays Investment Grade Non-Agency MBS Index

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