BlackRock: Outlook for 2017 bond markets

Ben Edwards, fund manager of the BlackRock Sterling Strategic Bond Fund and UK Corporate Bond Fund, comments on the outlook for bond markets in 2017.

BlackRock: Outlook for 2017 bond markets

2017 is shaping up to look a lot like 2016 – diverging regional economic paths, questioning of accepted policy tools, heightened political risk and general uncertainty.

Volatility dominated markets throughout 2016 and should continue to present opportunities as we transition to a world less supported by central bank monetary accommodation.

While political shocks in the developed world and the prospect of US led “reflation” have recently moved yields closer to fair value, structural problems still remain on a global scale. The one certainty for fixed income investors is that 2017 will provide opportunities to actively manage risk in volatile markets.

US

In the US, markets seem to be factoring in all of the upside and none of the downside of the proposed policies for the new administration. Benefits of fiscal expansion, tax cuts and deregulation are assumed, while the negative effects of lower world trade and political instability are, for the moment, ignored.

Ultimately, dollar strength is the binding constraint on the US economy and future rate hikes. Expectations for US monetary policy are clearly at odds with the rest of the world. This means we may see the effect of recent currency moves take hold, dampening US growth, before many of Trump’s policies are enacted.

Gilt yields

In the UK, resilient consumer spending is likely to give way to weaker business investment and construction in 2017. The effect of this more fragile growth outlook on gilt yields will be offset, to some extent, by higher government borrowing and higher, currency induced, headline inflation. However, the pound’s ability to depreciate further versus the euro, a currency which continues to face huge political and economic headwinds, will likely be tested.

Despite increasing confidence in US economic activity, it is difficult to ignore that Japan and Europe are still undershooting their inflation target significantly. China is in consolidation mode after a twelve month debt binge and many emerging economies will likely struggle with a stronger dollar and world trade (ex-US) that may be even lower than the current tepid levels.

While the efficacy and permanence of quantitative easing has been rightly questioned, the structural factors that drove yields lower – including demographics, weak productivity and excess savings – persist.

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