The global economy is facing numerous challenges. A trade war between the US and China has hurt global trade, causing business confidence to falter and manufacturing output to decline. A recent trade truce is welcome, but it’s unclear if it will last. And trade hostility is just one example of the geopolitical risks and the drift toward populist policies that have cast a cloud over markets.
It’s not all doom and gloom, though. Developed-market consumers continue to spend and labor markets—particularly in the US—remain healthy. That’s already prevented the manufacturing downturn from turning into a broader and more damaging economic slowdown and provides scope for optimism so long as weakness in manufacturing can be arrested, as now looks more likely.
But economic and political risks, including those tied to the 2020 US presidential election, remain high. In other words, we think it would be premature to declare that the economy has turned a corner. We expect global economic growth to slow to 2.4% in 2020. That’s better than we expected a couple of months ago but would still represent one of the weakest performances since the global financial crisis. And the risks are probably still skewed to the downside. So while recent developments have been encouraging, the outlook for the economy—and investors—remains highly uncertain.
Raising Yields, Reducing Volatility
Here’s what does seem certain: bond yields are likely to stay low for some time to come, while market volatility should remain high. So how can institutions boost income in today’s low-yielding, late-cycle world without taking on too much risk?
To start with, we think US dollar-based investors should globalize their safety-oriented core fixed-income strategies—but hedge the currency exposure.
There are more than 24,000 bonds in the Bloomberg Barclays Global Aggregate Index, and varying business cycles, monetary cycles and yield curves around the world mean country-bond returns differ from year to year. Investors who stick to their domestic markets are leaving a lot of opportunity on the table—even in today’s low-yield environment. And because US interest rates are higher than those in other developed economies, hedging a euro- or yen-denominated bond back to dollars can raise yields considerably (Display).
How to Increase Income Potential
A well-designed global core strategy can help to boost income potential without requiring investors to assume undue risk. But it isn’t enough. While many credit sectors, particularly in the US, are in the later stage of the cycle, abandoning return-seeking assets entirely isn’t a viable option. At this stage in the cycle, it makes sense to focus on credit sectors exposed to the healthiest parts of the world economy, such as US consumer or banking.
Investors may want to consider stand-alone allocations to relatively new or overlooked sectors that offer an appealing mix of yield, quality and downside protection potential. Two that we find attractive are US securitized assets backed by commercial and residential mortgages and subordinated European bank debt.