In the World

In stark contrast to the end of 2018, December 2019 featured strong risk asset performance across the globe, boosted in part by favorable developments in U.S.–China trade discussions. The U.S. and China announced an agreement on a first-stage trade deal, which included higher purchases of American goods by China and lower U.S. tariffs on Chinese goods. In addition to the decrease in trade tensions, more clarity on Brexit due to the Conservative Party’s resounding victory spurred demand for riskier assets; emerging (MSCI EM*) and developed market equities (MSCI World) posted positive returns (7.5% and 3.0%, respectively), while U.S. equity indices (S&P 500) closed the month at new highs – distinctly different from the nearly double-digit negative returns (–9.0%) for the S&P 500 in December 2018. Developed market sovereign bond yields predominantly rose over the month, with the U.S. 10-year Treasury yield up 14 basis points (bps) and the U.K. gilt 10-year yield up 13 bps. Credit markets also reflected the more robust risk appetite: Credit spreads (Bloomberg Barclays High Yield, U.S. Aggregate Credit, and Global Aggregate Credit indices) tightened, and, in a reversal from earlier this year, the lowest-quality junk bonds in the U.S. (rated triple-C) returned 5.7% in December. Reflecting this risk-on atmosphere, as well as some mixed domestic data, the U.S. dollar weakened significantly.

Central banks generally held policy steady against a backdrop of mixed fundamentals. In the U.S., the fastest pace of payroll gains since last January and another drop in initial jobless claims were balanced by a further dip in manufacturing purchasing managers’ indices (PMIs) to deeper contractionary levels. Consumer confidence remained robust, and inflation trended higher despite disappointing retail sales. Some U.S. trends were mirrored in the rest of the world as manufacturing PMIs in the U.K., eurozone, and Japan also dipped further into contractionary territory. Against this backdrop, global central banks held policy steady: The Federal Reserve voted unanimously to maintain current interest rates and indicated the need to see material deterioration in economic data to warrant further rate cuts; the Bank of England (BOE), citing tentative signs of stabilizing financial conditions, also held rates steady by a majority vote of 7-2; the Bank of Japan (BOJ), likewise, held rates steady. In addition, Japan’s Cabinet approved a $120 billion fiscal stimulus package in an effort to ward off global risks. Of note, the Swedish central bank raised rates again – in a departure from the easing stance of other central banks – returning to zero and ending its negative rate regime.

While trade tensions subsided, civil unrest escalated over the month. Political tensions continued throughout the world in December; pro-democracy protests in Hong Kong entered their seventh month, while new protests in India emerged over a controversial new “fast-track” citizenship law that some asserted discriminated against Muslims. Tensions in the Middle East also escalated, as supporters of an Iran-backed militia attempted to storm the U.S. Embassy in Baghdad. The situation exacerbated relations between the U.S. and Iran, and the Trump administration blamed Iran for orchestrating the attack. In the U.S., the Democrat-controlled House of Representatives voted along party lines to officially impeach President Donald Trump on two articles: abuse of power and obstruction of Congress. Trump will face trial in the Republican-controlled Senate in early 2020, where a two-thirds vote is required for conviction. Despite impeachment-related strife between the president and Congress, a resolution was reached on the U.S. Mexico Canada Agreement – also known as NAFTA 2.0 – and it was passed by the House.

*MSCI EM Net Total Return Index

 

Polarized Decembers

Your Decade Wrapped
December 2019’s 2.9% equity return (S&P 500) brought the annualized return over the decade to an impressive 13.6% – near the top decile of annualized equity returns for 10-year rolling periods in the past 30 years. The strong performance stood in direct contrast to the prior decade, which had a negative annualized return. This may not be surprising, given that the first decade of the 21st century was blemished by two recessions, whereas the second enjoyed uninterrupted (albeit modest) growth supported by ardent central bank easing. Perhaps more notable, realized volatility for the two decades sat at the edges of historical norms (top 5% in the first decade and bottom 1% in the second) – lending credence to the idea that suppressed volatility was a byproduct of unprecedented monetary policy support across the world in the decade that just wrapped.

In the Markets

EQUITIES

Developed market stocks1 rallied 3.0% into record territory in December as trade and geopolitical headwinds dissipated. U.S. equities2 climbed 3.0% amid strong employment data, passage of the United States Mexico Canada Agreement (USMCA), and a highly anticipated Phase 1 trade deal between the U.S. and China. European equities3 increased 2.1% as Christine Lagarde, in her debut as president of the European Central Bank (ECB), announced that the bank sees signs of economic stabilization. Meanwhile, the Conservative Party swept U.K. general elections, providing greater clarity on Brexit. Japanese equities4 returned 1.7%, supported by the passing of a large economic stimulus package.

Emerging market equities5 rallied 7.5% over the month as trade optimism and stimulus in China lifted global sentiment. In Brazil6, stocks soared 6.9%, and the real rallied on news of the U.S.−China trade deal and China’s stimulus as China is a major importer of Latin American commodities. Chinese local equities7 rose 6.2% after the People’s Bank of China reduced bank reserve requirements, freeing up liquidity for bank lending. In India8, the world’s third largest oil consumer, stocks rose 1.1%, buoyed by positive trade sentiment despite rising oil prices. Russian equities9 rose 4.7% as oil rallied on news that OPEC was considering additional production cuts.

Equity markets

DEVELOPED MARKET DEBT

Positive trade and Brexit developments supported investor sentiment in December, contributing to higher developed market yields and steeper yield curves. The U.S. 10-year Treasury yield rose 14 basis points (bps) to 1.92% with the spread between the two-year and 10-year yields ending the month on a high for the year. In Europe, the German 10-year bund yield ended 18 bps higher at –0.19%, and the 10-year yield in the U.K., further boosted by the general election results, rose 13 bps to 0.82%. Yields in Japan also rose, with the 10-year government bond yield ending 6 bps higher at 0.01%. Meanwhile, central banks – including the Fed, ECB, and BOJ – broadly held rates steady this month amid some signs of economic stabilization.

Developed market bond markets

INFLATION-LINKED DEBT

Global inflation-linked bonds (ILBs) posted negative absolute returns but outperformed their nominal counterparts in December. Inflation expectations rose amid the risk-on move across markets led by the news of a Phase 1 trade deal between the U.S. and China and higher energy prices. In the U.S., Treasury Inflation-Protected Securities (TIPS) posted positive absolute returns and outperformed nominal Treasuries. U.S. breakevens moved higher, consistent with the moves in equities, crude oil, and nominal yields. Outside the U.S., U.K. breakevens rose but lagged the rally seen in other major markets. The U.K. pound rallied significantly following the U.K. general election, in which the Conservatives won a comfortable majority in Parliament, clearing much Brexit-related uncertainty, but subsequently repriced lower as the market absorbed the election outcome.

Inflation-linked bond markets

CREDIT

Global investment grade credit10 spreads tightened 9 bps in December, ending the year at 92 bps, their lowest level since early 2018. The sector returned 0.18% for the month, outperforming like-duration global government bonds by 0.88%. Cyclical industries modestly outperformed, and risk markets reacted positively to reduced uncertainty around U.S.−China trade negotiations and Brexit.

Global high yield bond11 spreads tightened 42 bps in December, and the sector returned 2.09% for the month, outperforming like-duration Treasuries by 2.13%. Yields on below investment grade bonds declined sharply in December as sentiment received a boost from a Phase 1 trade deal between the U.S. and China. Energy was the largest outperformer in the month, although it still meaningfully lagged the broader index over the course of 2019. The higher-quality BB segment returned 1.25% for the month, while the CCC segment returned 5.65%.

 

Credit markets

EMERGING MARKET DEBT

As risk sentiment generally improved, emerging market (EM) debt broadly posted positive performance in December. External debt returned 1.88%12, driven by a 32-bp tightening in spreads, which outweighed a 14-bp rise in the underlying U.S. 10-year Treasury yield13. Local debt posted stronger returns of 4.13%14 as local rates fell modestly and currencies appreciated strongly on the back of U.S. dollar weakness. EM investor sentiment turned positive when a Phase 1 trade deal was reached and the U.S. House of Representatives passed the USMCA.

Emerging market bond markets

MORTGAGE-BACKED SECURITIES

Agency MBS15 returned 0.28%, outperforming like-duration Treasuries by 34 bps. December was the 15th month of the Federal Reserve’s balance-sheet unwinding: The Fed has cumulatively sold $380 billion in agency MBS, and its monthly runoff exceeded the $20 billion cap again, which allowed the Fed to reinvest the additional $7 billion back into agency MBS over the month. The December recovery in MBS was mainly driven by a favorable prepayment report, a steeper yield curve, and declining seasonal issuance. Higher coupons underperformed lower coupons, 30-year securities were mixed versus 15-year, and Ginnie Mae MBS underperformed Fannie Mae MBS. Gross MBS issuance decreased 3% versus November but remained strong at $165 billion. In November, prepayment speeds decreased 19% (most recent data available), which was slower than consensus expectations. Non-agency residential MBS spreads remained unchanged in December, while non-agency commercial MBS returned −0.10%16, outperforming like-duration Treasuries by 11 bps.

Mortgage-backed securities markets

MUNICIPAL BONDS

The Bloomberg Barclays Municipal Bond Index returned 0.31% in December, bringing the total return to 7.54% for the year. Munis outperformed U.S. Treasuries, as well as the Bloomberg Barclays U.S. Aggregate Index in December, as demand continued to buoy performance. High yield munis slightly underperformed investment grade munis over the month, returning 0.30%, which brought the year-to-date return to 10.68%. High yield performance was driven primarily by positive returns in Puerto Rico, as well as in the resource recovery and lease-backed sectors. Total muni supply was $39 billion in December, maintaining the trend of increased taxable issuance. Supply was down 14% compared to November, but up 77% year-over-year. Muni fund flows remained robust, marking 52 straight weeks of inflows: Investment inflows totaled $9.5 billion in December, which brought year-to-date flows to $93.6 billion, surpassing 2009 ($78.6 billion) and setting a new record.

U.S. municipal bond market

CURRENCIES

The U.S. dollar ended the month weaker (−2.0% based on DXY) than its developed-market counterparts on a combination of softer economic data, signaling of a likely extended pause in rate changes from the Federal Reserve, and improved investor sentiment as a Phase 1 trade deal was reached. Reflecting dollar weakness in spite of generally mixed activity data, the euro strengthened 1.7% versus the dollar. Similarly, the British pound strengthened 2.5% versus the dollar; initially, the strong result for the Conservative Party in the national election supported the pound, but later, the announcement that Prime Minister Boris Johnson would codify a December 2020 Brexit deadline in law was interpreted as increasing the possibility of a no-deal Brexit. Despite the improved risk sentiment overall, the Japanese yen – a traditional “safe-haven” currency – strengthened 0.8% versus the weakening dollar.

Currency markets

COMMODITIES

Commodity returns were positive in December, with all sectors ending the month higher. In energy, optimism around trade between the U.S. and China and among the U.S., Mexico, and Canada, rising tensions in the Middle East, and deeper OPEC+ production cuts supported prices. Forecasts for rising temperatures offset larger-than-expected declines in stockpiles, and natural gas prices declined. Agricultural products soared amid expectations for a trade truce to boost U.S. agricultural exports to China; soybean and wheat prices hit their highest levels since summer 2018. Coffee rallied in December owing to tightening supplies in Brazil. Base metals also moved higher, buoyed by encouraging economic data out of China and an improving trade backdrop. Despite improving sentiment, precious metals also remained well bid; gold prices surpassed $1,500/ounce even with the rally in risk assets.

Oil market

Polarized Decembers

FOOTNOTES:
1MSCI World Index, 2S&P 500 Index, 3MSCI Europe Index (MSDEE15N Index), 4Nikkei 225 Index (NKY Index), 5MSCI Emerging Markets Index Daily Net TR, 6IBOVESPA Index (IBOV Index), 7Shanghai Composite Index (SHCOMP Index), 8S&P BSE SENSEX Index (SENSEX Index), 9MICEX Index (IMOEX Index) 10Bloomberg Barclays Global Aggregate Credit USD Hedged Index, 11BofA Merrill Lynch Developed Markets High Yield Index, Constrained, 12JP Morgan EMBI Global, 13Generic U.S. 10-year Treasury, 14JP Morgan GBI-EM Global Diversified, 15Bloomberg Barclays Fixed Rate MBS Index (Total Return, Unhedged), 16Bloomberg Barclays Non-Agency Commercial MBS Index

Outlook

Based on PIMCO’s Cyclical Outlook from January 2020

Recession risks, which had been elevated during the middle part of 2019, have diminished in recent months, helped by additional global monetary easing, a trade truce between the U.S. and China, better prospects for an orderly Brexit, and early signs of a rebound in global purchasing managers’ indices (PMIs). As a consequence, we are now more confident in our baseline forecast that the current "window of weakness" for global growth will give way to a moderate recovery during 2020. Although the “time to recession” has increased, it is worth noting that monetary policymakers now have even less space to guard against future recessions after easing policy in 2019.

In the U.S., we expect growth to slow to 1.5%–2.0% in 2020 from an estimated 2.3% in 2019. We see a sharper growth deceleration in the near term due to the lagged effects of weak global growth, heightened business uncertainty, and slower corporate profit growth, followed by a reacceleration in the second half of 2020 due to easier financial conditions from government and central bank actions as well as higher expected exports to China under the Phase 1 trade deal. With a range of 1.75%–2.25%, core inflation is likely to firm modestly in the next few months from 1.8% last year before moderating later in 2020. Persistently below-target inflation suggests a higher tolerance for overshoots, and thus, a higher threshold for rate hikes from the Federal Reserve. While the Fed is expected to remain on hold, our view is their next move is more likely to be a cut than a hike.

For the euro area, we expect growth to reaccelerate gradually on the back of an improved global trade environment and ongoing support from monetary and fiscal conditions. We see euro area growth at around 1.0% in 2020. Inflation looks set to remain low, also around 1.0% on balance, with the impact of recent wage increases muted in the weak growth environment. We think the European Central Bank is likely to keep the policy rate at −0.50% and continue net asset purchases of €20 billion per month.

In the U.K., we expect growth of 0.75%–1.25% in 2020, modestly below trend.With the U.K. set to formally leave the EU at the end of January, uncertainty about future trading arrangements will likely weigh on business investment and sentiment. However, improving global trade and some fiscal easing should boost activity, especially in the second half of the year. CPI inflation looks set to be below the Bank of England’s 2% target in 2020, in part because of scheduled cuts in regulated electricity and energy prices. We expect the policy rate to remain unchanged at 0.75% but with some risk of a cut in the first half of the year if activity fails to pick up.

In Japan, our forecast is for growth to slow to 0.25%–0.75% in 2020 from an estimated 0.9% in 2019. The VAT hike in the fourth quarter of 2019 is likely to slow growth in the first half, but a large fiscal stimulus package and steady domestic private demand should boost activity in the second half. Inflation is expected to remain low at 0.25% –0.75%. In case of downside risks to global growth, more fiscal support is likely, and we expect the Bank of Japan to keep interest rates unchanged given improving external risks.

In China, we see growth slowing to 5.0%–6.0% in 2020 from an estimated 6.1% in 2019. The Phase 1 trade deal should boost business and consumer sentiment, helping to stabilize slowing trends in the economy. Fiscal support of around 1% of GDP, focusing on infrastructure investment, should also cushion growth. Consumer price inflation has breached the central bank’s 3.0% target recently and is likely to stay in the 3.0%– 4.0% range in 2020. The People’s Bank of China is effectively on hold in an effort to anchor inflation expectations. We expect 2020 will bring a moderately stronger yuan to limit pass-through from import prices under the trade deal with the U.S.

Related Content

Section : Date : Experts :
Reset All

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Milan
PIMCO Europe Ltd - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Munich
PIMCO Deutschland GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10


PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Italy branch is additionally regulated by the CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are  authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Swedish Branch is additionally supervised by the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act. he services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser.

A “safe haven” currency is a currency perceived to be low risk due to the stability of the issuing government and the strength of the underlying economy.  All investments contain risk and may lose value.

Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation- Protected Securities (TIPS) are ILBs issued by the U.S. government. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. It is not possible to invest directly in an unmanaged index.

The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively.

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2020, PIMCO.