“Fixed Income Markets-Global Perspective” by Dr. Arvind Rajan, CFA at 1st India Fixed Income Summit, Chennai-2019

Speaker- Dr. Arvind Rajan, CFA, Managing Director, PGIM Fixed Income, USA

Contributed By: Deivanai Arunachalam

Arvind Rajan, CFA, Managing Director, PGIM Fixed Income, presented themes from both global and emerging markets. His two main conclusions were:

1. The Global Economy will expand. Growth, although positive, will be anaemic.

2. Interest rates will continue to bounce along the lower range.

Even though rates are low, it will not be an easy ride as markets will be skittish.

Below – excerpts from the speech

Growth and debt outlook

Preservation of low interest rates is crucial to preserve macroeconomic order. Global growth has dropped dismally. PMI (both manufacturing and services) fall is bottoming out. Services have been less weak than manufacturing over the last several months. It is likely that the global economy will bounce back in the next quarter or two.

There has been an increase in global government debt. As a country gets richer, non-financial debt increases. As more countries grow, we should expect to see even more debt.

The trade war has increased stock market volatility. The Fed has been injecting liquidity, though not through explicit QE. The ECB may use firepower to buy assets. Emerging market central banks are expected to buy assets too.

The US is at almost full-employment. Employment levels in Asia are reasonable. And most of Europe’s problems are internal. In my opinion, the global situation has improved. The issue now is the situation of low interest rates, which monetary policy cannot resolve. Without QE, things would have been far worse. Fiscal easing should be the next step. India too will witness fiscal easing.

The turn in demographics also presents a concern. Working age population as a proportion of total population has dropped. And China is fast experiencing this trend. Japan was the first country to witness this trend. As a result the country faces lower growth and lower inflation. An ageing population has fewer propensities to spend; prices are kept under check; workers cannot demand higher wages. Automation augments these trends. Working age population is positive correlated to both inflation and interest rates.

China outlook

China has maintained an accommodative stance. Add to that the loose fiscal policy in Europe. With the natural bottoming of sentiment, economic growth will pick up.

Which factor led to anaemic global growth over the last decade? Export growth from China to Europe which was 5-10% between 2000 and 2010 has fallen to 2-3% in the last few years. While Europe had a major crisis, post the crisis of 2008-09, China has been gradually fading, thanks to extensive protectionism. Overall trade has shrunk and attention is moving towards domestic consumption in China.

There are growth risks in China. Global manufacturing recession may have a contagion to services. There is a possibility of escalation of tensions in Hong Kong/Middle East.

China has engaged in rebalancing for many years – be it from manufacturing to services, from export led growth to domestic demand, resource intensive production to greener means, from being high on leverage to toning it down, moving the focus from investment to consumption and from a Public State Owned-Enterprise system to one with greater private participation. Debt to GDP ratio is at 300% and is increasing. This is likely to exert downward pressure on interest rates.

China’s pains may be India’s gain. Donald Trump views China as a strategic competitor to the USA. A trade agreement between India and the USA can improve the situation for both countries. I see a 70% chance of a trade dealing in the next 2-3 months.

Emerging markets

I expect emerging markets to grow at faster rates than developed countries. Emerging markets will maintain moderate policy rates accompanied by moderate inflation. EM hard currency debt is the second best performing asset class after US equities. Since EM debt is just moderately correlated with other asset classes, it will prove to be a good diversifier. EM spread is still attractive, given the level of credit risk.

EM local bonds have outperformed those of developed countries. Specifically, the duration of Indian bonds looks good.