2016 Fixed Income Outlook

For some time, commentators have been itching to call the top of the great bond bull market. They point to improving economic conditions in the developed economies, a tightening US labour market and a long-awaited normalisation of interest rate policy after many years of extraordinary stimulus as evidence for their case. It has also been suggested that bonds have simply entered a bubble which, like all bubbles, must eventually burst.

Far from being at the start of a great normalisation, we believe that interest rates are likely to remain low for a long time. We think the ability of global central banks to raise rates will be limited in an environment where high debt levels and aging populations in much of the developed world continue to act as impediments to economic growth.

The development of new, disruptive technologies represents another headwind to global inflation. In this context, we expect any tightening of global monetary conditions to be gradual and we believe that duration will continue to perform well.

In the short term, we worry that the risk of a policy error by the US Federal Reserve has increased. After months of speculation and several aborted attempts, the world’s most powerful central bank finally acted, raising its target range for the Federal Funds rate by 25 basis points. In some ways, it is a little too late; it almost seems as if the Fed is looking to atone for its failure to begin normalizing monetary policy earlier in the cycle, before the imbalances in the global financial system became so pronounced.

That window has now closed, and in our view the Fed may come to regret this December rate increase, particularly given that the slowdown in global trade now appears to be affecting US manufacturing.

In our opinion, this US economic recovery is built on shaky foundations. In challenging economic conditions, we think governments with sound finances and control over their printing presses should provide an effective hedge against further deflationary shocks.