Market commentary

During Q4 2019, global developed markets continued to trade cautiously following the repo market turmoil observed in the previous quarter. Yields overall have trended higher from their August lows on growing economic optimism in the US and increasing uncertainty surrounding the future of negative interest rates in the eurozone with the changing of the guard at the European Central Bank. However, at the start of the new decade, the growing chorus for global rising yields was shouted down rather quickly by the novel coronavirus (Covid-19) outbreak in China. The outbreak compounded fears of a further global growth slowdown and put Germany in an ever more precarious position given the country’s already weak export and industrial production numbers. While we initially thought getting past the drama of US President Donald Trump’s impeachment could be a catalyst, the baton was merely passed on to a new source of geopolitical uncertainty.

From a market standpoint, and not to ignore the significance of the human impact of the viral outbreak, China has taken drastic measures restricting travel and instilling quarantines on several cities. We have observed a rather dramatic decline in commodity demand from China, with Brent crude prices down nearly 17% YTD on the slowdown. With growing uncertainty surrounding the duration of the outbreak, China’s aggressive action to combat the spread and the follow-on impact to domestic demand certainly raises our concerns that this black-swan event will, in the least, weigh on global growth in the first quarter. It therefore raises concerns that the outbreak could remain a drag on global growth beyond the first quarter. Beyond the direct observation in the fall in commodity prices, we also note Alibaba Group’s recent warnings that the Covid-19 outbreak is exerting a fundamental impact on the country’s consumers and merchants, and will therefore hurt its revenue growth. Regardless, a fall in commodity prices and declining global growth are expected to have a deflationary impact, and as such we do not see any impetus for central banks to hit inflation targets as they face such strong headwinds.

Outlook for Q1 2020

We have yet to observe significant changes in economic data, with the exception of Germany, which has already been trending negative. From a portfolio standpoint, the team remains slightly overweight duration, but it has taken to relative value positioning given the conflicting signals coming from political events and stronger US economic data. The team moved to extend duration in the eurozone across all markets on the slowing economic outlook while keeping its long positioning in the periphery on continued spread convergence.

In Australia and New Zealand, the team has maintained its long positioning because of increased QE risk out of the Reserve Bank of Australia as a result of the China slowdown while underweighting New Zealand duration due to a more hawkish Reserve Bank of New Zealand. For Canada, the team has increased exposure based on expectations for a more dovish policy rate outlook and potential earlier-than-expected-cut from the Bank of Canada (BOC). Moving onto UK rates, the team maintains a slightly negative bias given higher local inflation and a more positive outlook on the UK economy, while remaining cautious of becoming too underweight considering our deteriorating views on the eurozone and Gilt correlation with European rates.

On a currency standpoint, the team remains positive on the USD as US growth expectations are upbeat relative to other developed markets. The team retains its negative view on European currencies on the slowdown in Germany. The team is negative on the Norwegian kroner because of the decline in oil prices; it is also negative on the Swedish kroner due to expectations of limited policy action from the Riksbank given their shift on negative rates. For Canada, the team has moved to negative on the expectation that the BOC is more than likely to cut at its next meeting due to its reduced competitiveness in the face of US tax equalisation. For the Australian and New Zealand dollars, the team has maintained its negative outlook on the China slowdown view. For the pound (GBP), the team has maintained its positive outlook and maintains its positioning on the belief that reduced political uncertainty will translate into GBP strength over the longer-term.