Growth in the US and across the globe is expected to decelerate from their cyclically driven highs into 2022, according to leading fixed income investment manager Western Asset’s Quarterly Outlook.
Western Asset, which is part of Franklin Templeton, notes: “Contributing factors include a sharp reduction in global fiscal stimulus, a reduction in monetary accommodation by key central banks such as the US Federal Reserve and the European Central Bank and the persistence of secular-related headwinds that include rising global debt burdens, aging demographics and technology displacement.
“Inflation remains challenging for policymakers, but we expect the impact of supply-chain disruptions to ease meaningfully through the course of next year. While COVID-19 continues to bedevil global populations, we are optimistic that the worst is behind us, which bodes well for the continued recovery of reopening sectors and spread product performance.”
EXECUTIVE SUMMARY
- Western Asset expects US and global growth to decelerate from their cyclically driven highs as we move into 2022.
- In the US, Western Asset expects growth in the service sectors to continue to disappoint relative to consensus expectations and that growth in manufacturing and construction sectors will be muted as the recovery there is already complete.
- While European growth momentum can continue well into 2022, the main risk to our outlook is shifting for now from new COVID-19 variants to bottlenecks creating additional supply-side disruptions.
- While near-term growth challenges likely will persist in China due to a cyclical slowdown and policy-induced pain, Western Asset does not expect full-blown economic destabilization.
Global Market Rates
US: Western Asset expects rates to remain range-bound with the 10-year trading within 1.25% to 1.75%.
Western Asset expects growth in the service sectors to continue to disappoint relative to consensus expectations and that growth in manufacturing and construction sectors will be muted as the recovery there is already complete.
AUSTRALIA: Western Asset favors high-grade supranational debt sector with a focus on the mid-curve 7- to 10-year bonds. Western Asset is mildly negative on semi-government bonds that now look expensive thanks to quantitative easing (QE) buying.
Lockdowns have delayed the recovery, but not derailed it, with Q4 expected to see a strong post-delta recovery; growth forecasts for 2022 have been upgraded as well. The Reserve Bank of Australia (RBA) “has a glass half-full view” on the recovery, but still remains very dovish, focused solely on getting inflation back to target levels of 2% to 3%.
EUROPE: The impact of potential further reduction of asset purchases is counterbalanced by more expansionary fiscal policies in core countries and Western Asset doesn’t see a strong impact on spread levels.
Strong growth and domestic fiscal support should keep the economic recovery going deep into 2022. The ECB is likely to gradually phase out its emergency measures, but will continue to strive for a very accommodative policy stance as inflation is likely to recede in early 2022.
CANADA: Provincial and corporate spreads are expected to remain near current narrow levels as the Canadian economy reopens. While longer-term bond yields may still move higher, Western Asset don’t expect the two rate hikes by the BoC that are already priced into the 2022 curve.
Rate hike expectations have been brought forward despite the mid-year COVID-19 setback. Western Asset remains optimistic that GDP growth continues to recover in Q4. While near-term growth and inflation justify some recalibration, Western Asset still believes we will get a cautious rate hike cycle by the Bank of Canada (BoC).
JAPAN: Western Asset expects higher yields on the long end. The Bank of Japan is likely to keep interest rates very low for a long time with a steepening bias in the yield curve.
Western Asset expects that the Japanese economy will grow 2.5% in 2021 and 3% in 2022, rates that are slightly higher than consensus forecasts. Western Asset believes that new Prime Minister, Fumio Kishida, will continue the current expansive and supportive economic policies at least in the short run.
CHINA: Western Asset expects rates to remain low with and long-term rates well anchored by targeted tightening and a universal easing approach toward all macroeconomic levers.
While near-term growth challenges will persist in China, Western Asset does not expect full-blown economic destabilization. Weaker growth is acceptable to policymakers to achieve their long-term strategic objectives as long as weaker growth does not translate into significant job market weakness or financial instability
UK: Western Asset feels that the market has been pricing too fast a degree of monetary policy normalization, but Western Asset believe that bond yields will have to increase further over time.
The UK is currently running into supply constraints that are likely to be temporary and should resolve during the course of Q4. The BoE is likely to raise rates at some point next year.
