(Jan 31): There was a period of time during the late summer when a reality seemed to dawn on many of our European clients — that the world of negative rates was not just a fleeting blip. It now appears likely that we could remain in a negative yielding environment for a number of years. But being caught in a new reality does not mean peril. My view is that we are not in imminent danger of a recession. Without an unforeseen shock, conditions for a widening of credit spreads or a sell-off of risk assets do not exist at this point.
As institutional investors reach similar conclusions, the way that they invest is adapting. In order to generate positive returns, many are beginning to consider pushing out their duration, moving down the credit spectrum, giving up liquidity or taking on leverage. This is pushing up demand for those asset classes that can offer steady, fixed income like returns, but may be out of traditional comfort zones or require more homework and risk management. These include private credit, high yield debt, emerging market debt, infrastructure and real estate.
Some of these asset classes have evolved in recent years and are now worthy of consideration for a wider range of investors. Included in today’s emerging market debt indices for example are countries with robust and relatively balanced economies, such as South Korea. Moreover, many companies in these countries are increasingly issuing local currency bonds, meaning they are more insulated from swings in the dollar as we enter an election year and an inflection point in Fed monetary policy.
In developed markets, with the scope to move rates in either direction looking unclear, there has been a great deal of emphasis on a shift to fiscal stimulus. In the early days of Christine Lagarde’s ECB (European Central Bank) tenure, it seems a primary focus of the new Chair will be to encourage fiscal packages in major Eurozone economies as a means of staving off a downturn. The US and UK may also look set to push forward on a path of fiscal easing in 2020 depending on electoral outcomes. The question is whether these packages can actually move the needle on growth. The fiscal measures would need to be extremely significant to do so. Japan offers us a blueprint, demonstrating that fiscal expansions do not necessarily lead to higher growth and inflation rates.
As things stand, the world is more likely to experience a prolonged period of low growth — with global growth levelling off at around 3%. There is no obvious catalyst for a meaningful upward move in inflation and there appears to be no imperative for central banks to raise rates.
In 2020, we see a recession as unlikely but nevertheless it will be a year of important choices for fixed income investors. A lowgrowth, low-inflation and low-return environment is not a cause for panic, but should prompt a rethink from institutional investors about their allocations within fixed income.
Andrew Wilson is EMEA CEO and global head of Fixed Income, Goldman Sachs Asset Management
