Former chief economist of ANZ Banking Group, Bank of America Merrill Lynch (Australia & New Zealand) and National Mutual Funds Management, Saul Eslake last year joined the advisory board of active bond fund manager, Jamieson Coote Bonds. In a recent note to JCB clients he outlined the key themes for bond investors to monitor in 2016. The start of 2016 has been volatile with numerous issues grabbing investors attention so it might pay to keep these themes in mind as the year unfolds.
CHINA
According to the IMF China is now the world’s biggest economy and has accounted for almost one-third of the growth in the world economy since 2008/09. It accounts for one-seventh of world trade in goods, almost one-third of Australia’s exports and one-quarter of the world’s savings. The Chinese economy is slowing and the mix of growth in China is changing. Most likely, the slowdown in growth will continue to be gradual. China’s financial system could be a source of significant volatility for the entire global financial system and a large devaluation of the yuan would add renewed impetus to the deflationary pressures in advanced economies.
THE US FED
The Fed would like to continue down the path of normalising US monetary policy settings this year but this is predicated on:
- the US economy continuing to grow sufficiently to keep the unemployment rate around 5% while keeping broader measures of under-employment on a downward trajectory (likely)
- the Fed’s preferred measure of ‘core’ inflation continues heading back towards 2% (probable but by no means guaranteed).
A large and sustained fall in equity markets, or a large and sustained rise in the US dollar, would likely see the Fed putting its hopes of a “return to normalcy” on hold.
OIL PRICES
The huge fall in oil prices over the past 15 months has done less to stimulate growth in oil-importing countries than expected, pushed some oil-exporting economies into recession, added to lingering global deflationary pressures and given rise to some credit market concerns in the US. Oil prices could well have further to fall, as the contest for long-term shares of the oil market continues. Prices of other key commodities appear to have stabilized for now but may resume their decline if China slows further or devalues its currency aggressively.
HOUSEHOLD DEBT
Debt owed by households, businesses and governments in emerging markets, including China, has increased by about US$25 trillion since the onset of the financial crisis, or about 185%. By contrast, non-financial sector debt outstanding in advanced economies has risen by US$16 trillion (or 21%) over the same period and more than half is by way of US government debt. While most of China’s debt is owed to Chinese financial institutions, China still has cross-border liabilities of nearly US$600 billion, most of which are unhedged and thus open to exchange rate risk. Higher US interest rates and a stronger US dollar could undermine the capacity of emerging market/Chinese issuers to service existing debts.
US ELECTIONS
If by some chance opinion polls start to suggest that Donald and Melanie Trump could be moving into the White House, financial markets around the world may well take fright. A close-looking election could also provide yet another complication for the Fed in its scheduling of US interest rate increases.
EUROPE
The euro zone economy does seem to be experiencing a gradual recovery and the probability of a renewed European debt crisis is quite low. However the European Central Bank is likely to remain concerned at the downside risks to inflation, implying more quantitative easing and a further decline in the euro. The other key issue for Europe will be the prospect of British withdrawal from the EU and a referendum has to be held before the end of next year. A “no” vote would be a major shock to financial markets.