Fixed Income

Slowdown and Upset Ahead

Slowdown and Upset Ahead
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Voter discontent and unpredictable geopolitical headwinds could deliver fresh electoral surprises in the year ahead and help spur a new economic policy approach, says Newton Investment Management fixed income investment leader Paul Brain.

After a year of political shocks, including the UK’s vote to leave the European Union (EU) and U.S. election victory for Donald Trump, Brain anticipates a period of steady growth this year. However, he believes this will be followed by an economic slowdown in 2018 and warns of the potential for more political upsets ahead.

Brain adds that rising wealth inequality and a growth in populism could ultimately force policymakers to shift their approach away from fiscal austerity and persistently low interest rates in order to boost economic growth.

“While the U.S. economy is growing, buoyed by previous monetary stimulus, and economic recovery is underway in Europe, inflation is rising quite sharply and central banks need to consider their monetary policy carefully. Investors should also monitor the changing economic outlook and guard against potential market upsets,” he says.

POLITICAL RISK

From a political standpoint, Brain sees potential risk ahead in the forthcoming UK and French parliamentary elections, with the outcome of the next Italian election also of major significance to the Eurozone.

“As we saw with the Brexit vote last year, there is a lot of dissatisfaction with the current state of play. It is possible this feeling of discontent will linger throughout the upcoming elections in the UK and France— leading to a demand for a change in government policies that could lead to a slippage in fiscal prudence.”

“In Italy, anti-establishment sentiment is also rising. Italian public support for the EU and euro is currently among the lowest in Europe, which is a concern,” he adds.

Commenting on the U.S. economic landscape, Brain predicts further interest-rates rises from the U.S. Federal Reserve will cause bond yields to spike upwards and inflation to return later this year. He adds that much depends on President Trump’s ability to deliver on policy promises. After an abortive attempt to reform U.S. health care, he adds, Trump now looks unlikely to force through major tax changes in the short term.

Against this backdrop, Newton’s global bond team is applying a flexible investment approach within its strategy. Outlining the tools, which drive the strategy, Brain said he currently favors U.S. Treasury Inflation-Protected Securities (TIPS) and bank bonds and the team has built exposure to assets within the U.S. construction/reconstruction sector. Brain remains bullish on some emerging markets, despite ongoing credit problems in countries such as Brazil and South Africa and the potential for further fi instability in China.

The global bond team does, however, remain cautious on the high yield bond sector.

Regarding this topic, Brain adds: “If you consider how much high yield investors get paid in terms of actual yield, and also the likelihood of rising default rates over the next two years, then they are not particularly well rewarded. With the added potential for volatility in the sector, we fear this is an asset class that could be an accident waiting to happen.”

BNY Mellon Investment Management is one of the world’s leading investment management organizations and one of the top U.S. wealth managers. It encompasses BNY Mellon’s affiliated investment management firms, wealth management services and global distribution companies. More information can be found at www.bnymellon.com.

RISKS

Bonds are subject to interest-rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. While the U.S. government guarantees the timely payment of principal and interest on its securities, portfolios that invest in such securities are not guaranteed and will fluctuate in value. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries.

“Newton” and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Investment Management (North America) Limited (NIMNA Ltd) and Newton Investment Management (North America) LLC (NIMNA LLC). NIMNA LLC personnel are supervised persons of NIMNA Ltd and NIMNA LLC does not provide investment advice, all of which is conducted by NIMNA Ltd. NIMNA LLC and NIMNA Ltd are the only Newton companies to offer services in the U.S. Newton is a wholly owned subsidiary of The Bank of New York Mellon Corporation.

Canada: Securities are offered through BNY Mellon Asset Management Canada Ltd., registered as a Portfolio Manager and Exempt Market Dealer in all provinces and territories of Canada, and as an Investment Fund Manager and Commodity Trading Manager in Ontario. BNY Mellon Asset Management Canada Ltd. is an indirect wholly owned subsidiary of The Bank of New York Mellon Corporation (BNY Mellon). BNY Mellon Asset Management Canada Ltd., 200 Wellington Street West, Suite 305, Toronto, ON M5V 3C7. Views expressed are those of the advisor stated and do not reflect views of other managers or the firm overall.

Views are current as of the date of this publication and subject to change. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Newton and MBSC Sec Y Mellon. ©2017 MBSC Securities Corporation, Distributor, 225 Liberty Street, 19th Fl., New York, NY 10281.

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