On Global Fixed Income

Will Central Banks Keep Fueling the Rally?

Kenneth A. Orchard, Portfolio Manager/Analyst

Key Insights

  • Central banks have become notably more dovish during the first few months of this year, prompting a risk rally.
  • The most likely outcome of this is that global growth rebounds and the risk rally extends into next year.
  • A second possibility is that stimulus prevents a recession this year but fails to revive animal spirits, increasing the likelihood of a recession next year.
  • A less likely outcome is that the Fed engineers a “stealth” easing without cutting rates and the economic cycle is refreshed.

Central banks have become notably more dovish during the first few months of this year, prompting a risk rally. Were they right to soften their policies? I believe so. A major reason for last year’s volatility, including the sell‑off in the fourth quarter, was concern over excessive monetary tightening. Simultaneous tightening from the Federal Reserve and the People’s Bank of China during a period of sluggish global growth and heightened economic uncertainty prompted widespread jitters and led to heavy waves of selling in November and December.

The banks were slow to react to this. This is perhaps understandable given that the role of central banks is to set policy for the long term and it does not inspire confidence if they are too reactive. On the other hand, if the leading central banks had softened their policies slightly earlier, they probably would not have had to soften policy so much. Given what transpired, though, it is difficult to see them becoming more hawkish again anytime soon.

Opening Quote The first scenario is that the combined stimulus efforts from the U.S., China, and the eurozone cause global growth to rebound. Closing Quote

What happens now? I see two main possible scenarios and a third “outlier” scenario. The first scenario is that the combined stimulus efforts from the U.S., China, and the eurozone cause global growth to rebound. This extends the current risk rally, leading to higher neutral interest rates and a bear‑steepening of yield curves (when long‑term rates increase at a faster rate than short‑term rates). Later this year, as U.S. fiscal stimulus begins to wear off, the dollar weakens, and commodity prices rise. This could prolong the risk rally by another six to 12 months.

The second scenario is that the stimulus being pumped into the global economy is sufficient to prevent a recession this year, but insufficient to rekindle animal spirits. Curves remain flat, and the economic cycle is not extended. The probability of a recession in 2020 rises significantly and, as U.S. fiscal stimulus wanes, the market begins to price in Fed rate cuts, resulting in a bull‑steepening yield curve (when short‑term rates fall faster than long‑term rates). In this scenario, commodity‑linked assets would fall and the U.S. dollar would probably strengthen.

Opening Quote ...the evidence suggests that our outlook for the year is playing out and that risk assets will continue to perform. Closing Quote

The outlier scenario is that the Fed engineers a stealth easing, getting bill rates to decline well below the overnight indexed swap rate—without actually cutting rates. This would support growth, weaken the dollar and help to refresh the economic cycle. But I doubt the Fed would be this creative.

The first scenario remains the most likely, in my view. The combination of stronger Chinese credit growth in January, declines in market‑implied volatility, and higher commodity prices (e.g., copper) suggest that the risk rally will continue for at least a few more months and that conditions remain supportive for credit markets. Around Christmas, we took off most of the credit hedges in our Global Multi‑Sector Bond and Diversified Income Bond portfolios and adopted a more aggressive stance on risk in the U.S., Europe, and emerging markets. This remains our stance today. So far, the evidence suggests that our outlook for the year is playing out and that risk assets will continue to perform. But we are ready to adjust our portfolio quickly if the data begin to suggest otherwise.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of March 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc., Distributor.

© 2019 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

Dismiss
Tap to dismiss

Manage Subscriptions

Unsubscribe All
OK

Manage your watched Funds and Insights subscriptions here.

OK

Change Details

Congratulations! You are now registered.

Begin watching and receiving email updates for:

Ok

Sign in to manage your subscriptions and watch list.

Register

Download

Latest Date Range
Download Cancel

This content is restricted for Institutional Investors use only. We were not able to validate your status as an Institutional Investor with the information you provided at registration.

Please contact the T. Rowe Price Team with questions or to revise your status.

1-800-564-6958

You will need to accept the Terms & Conditions again.

Ok

You have updated your email address.

An activation email has been sent to your new email address from T. Rowe Price.

Please click on the activation link in order to receive email updates.

Ok

You have an existing account

Click OK to view your subscriptions and watch list.

OK

Confirm Cancel