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Global Fixed income markets • Soo Boo Cheah, CFA • Suzanne Gaynor Twist” ends this month. The LTRO program was a huge success initially, but the effect is wearing off quickly. The only new intervention has come from the Bank of Japan, which essentially put a floor on prices of short-maturity JGBs and potentially upward price pressure on longer-maturity JGBs. At the moment, all central banks are in stand-by mode, and will act to maintain extraordinarily low yields in case the crisis worsens. If European policymakers and politicians can avert a disaster, bond yields will likely rise. Another factor holding down bond yields has been disappointing U.S. economic data. However, the statistics must be viewed in the context of the past two years. In recent times, the pattern has been for economic news at the beginning of the year to be generally upbeat, before gradually turning south into the summer months and then improving again in the autumn. Assuming the pattern in Exhibit 3 persists for the rest of this year, economic data should start turning up in late summer. The possibility of stonger growth is not supportive of the idea that bond yields will stay at current low levels. Government bonds are the preferred investment in today’s highly uncertain investment environment. Over the past three years, developed markets have gone through a cycle that we have dubbed a “policy addiction loop.” This occurs when policymakers intervene in government fixed-income markets following significant declines in stocks and other risky assets. This has generally pushed up stocks only temporarily, prompting policymakers to resume intervening. Each time Exhibit 3. Economic Data Surprise Index (Analogue) 150 100 50 0 -50 Upside Surprise for the U.S. Economic Data 2012 -100 -ve Surprise -150 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Citigroup, Bloomberg they step in, the doses get bigger. In Europe, we are at the juncture where band-aid solutions will no longer suffice, and markets are pricing in a high probability of the worst possible outcome: the uncontrolled exit of Greece and subsequent spread of financial contagion around the world. Absent this extreme scenario, bond yields would likely move higher. Deleveraging is also on the minds of investors. The European crisis to some degree foreshadows the progress of balance-sheet repair by the U.S. private sector following the financial crisis. Using a Citigroup road map that measures change in privatedebt relative to GDP before and after systemic banking crises, the U.S. went through a similar experience. Since the beginning of the 2008 crisis, privatesector debt as a percentage of GDP has been falling at a rate that is similar to that experienced by other countries. To date, the U.S. private sector has completed three out of the first four most painful years. There may be further deleveraging, but it will likely be to a lesser degree than before. +ve Surprise 2011 2010 Where exactly do we find ourselves in the deleveraging cycle? H.W. Brock, the president of Strategic Economic Decisions (SED), argues that the longterm relationship between wealth and output provides the key to figuring out when deleveraging will begin winding down. Exhibit 4 shows U.S. household net worth (wealth) as a multiple of nominal GDP (output). Between 2005 and 2008, the multiple rose to unsustainable levels and was followed by crisis and deleveraging. The last data point shows the multiple is approaching the long-run average and signals that less aggressive U.S. deleveraging is required. SAMPLE A more intuitive way of considering sustainable wealth is through the multiple of net worth to household disposable income (Exhibit 5). In a trend that resembles the Brock model, U.S. household wealth relative to disposable income has fallen from levels during the 2005-2008 period, and currently rests at the long-term average multiple. Judging from both the wealth-to-output and net worthto-disposable income measures, 36 I The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012
Global Fixed income markets • Soo Boo Cheah, CFA • Suzanne Gaynor U.S. private-sector balance sheets are on a much firmer footing than is generally believed and suggests further aggressive deleveraging is no longer warranted. This argues for a more conservative stance toward bonds. Bond yields at their current low levels are pricing in a raft of bad news. We acknowledge that the threat from the European crisis could wreak havoc on financial markets, leading to even higher fund flows into safe-haven government bonds. Concern about the Eurozone is less about the departure of Greece and more about the secondary effects on other peripheral economies and bond markets. The most likely immediate impact would be a surge in sovereign-risk premiums for other member states. This would be met with temporary capital controls across the EMU to curb bank runs, choking off credit and likely destroying wealth around the globe. In the U.S., politics are highly polarized, suggesting that much needed private investment to boost the economy is off the table until at least after the November election. The looming “fiscal cliff” – a mix of higher personal taxes and lower spending – could pare as much as 4% from U.S. economic growth and further depress U.S. Treasury yields. We do not place much weight on this worstcase scenario. The other risk pertains to an economic-growth slowdown in emerging markets, where relatively fast growth has been offsetting nearrecessionary conditions in much of the developed world. The plethora of nearterm risks could send bond yields to new lows. While the aforementioned risks could push yields to new lows over the short Exhibit 4. Multiple Exhibit 5. Multiple 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 U.S. Net Worth to Nominal GDP Average = 3.6x Source: SED, Bloomberg, RBC GAM U.S. Net Worth to Personal Disposable Income Average = 4.9x 3.0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Source: Bloomberg, RBC GAM SAMPLE term, we believe a reflation trade could emerge in the longer run. We expect more pro-growth governmental policies to appear in the pipeline. This scenario would contravene the extreme pessimism embedded in bond prices and warrant a reallocation out of safehaven assets. Bond yields are most at risk under this scenario, especially given their extremely rich valuations and crowded positioning. Also, the rationale for holding bonds to preserve capital is getting less appealing as rates fall. A small jump in interest rates would more than erase any returns from income as capital erodes. This is the thinking behind our bias for higher rates, but we are conscious that this is a bet on policymakers coming up with solutions that can bridge today’s polarized politics. Direction of rates We remain mildly bearish on bonds over the next 12 months. Our yield forecasts for Canada and the U.S. are a touch higher than they were in the previous quarter, reflecting The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 37
Page 1 and 2: The Global Investment Outlook RBC I
Page 3 and 4: Contents Executive Summary 2 The Gl
Page 5 and 6: Executive summary • Sarah Riopell
Page 7 and 8: Recommended Asset Mix Asset mix - t
Page 9 and 10: Recommended Asset Mix Balanced Asse
Page 11 and 12: Capital markets performance • Mil
Page 13 and 14: Global Investment Outlook Eric Lasc
Page 15 and 16: Global Investment Outlook • Eric
Page 37: Global Fixed income markets • Soo
Page 41 and 42: Global Fixed income markets • Soo
Page 43 and 44: Global Fixed income markets • Soo
Page 45 and 46: Currency Markets Dagmara Fijalkowsk
Page 47 and 48: Currency markets • Dagmara Fijalk
Page 57 and 58: Regional outlook - U.S. • Ray Maw
Page 59 and 60: Regional outlook - CANADA • Stuar
Page 61 and 62: Regional outlook - Europe • Domin
Page 63 and 64: Regional outlook - Asia • Yoji Ta
Page 65 and 66: Regional outlook - emerging markets
Page 67 and 68: Eric Lascelles Chief Economist RBC
Page 69 and 70: This report has been provided by RB

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