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2017 Market Outlook - Global Fixed Income

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Portfolio Manager Quentin Fitzsimmons discusses his perspective on the current global fixed income environment and what investors could expect to see in 2017.

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2017 Market Outlook - Global Fixed Income

  1. 1. GLOBAL FIXED INCOME Quentin Fitzsimmons Portfolio Manager November 17, 2016 2017 Global Market Outlook Press Briefing
  2. 2. 2 Global Fixed Income Outlook: Summary ENVIRONMENT  Historically low yields continue to be evident in many international fixed income markets, pointing to divergence away from the U.S., where policy rates are being very gradually increased. Around the world, political patience with accommodative monetary policy is wearing thin as economic growth remains low. More generally, investors are questioning the balance between monetary and fiscal policy and how a greater reliance on the latter may impact fixed income opportunities. (At the same time, the rebound in the price of oil is causing subdued inflation rates to base and challenge fixed income valuations for many.) LOOKING AHEAD  The interplay between slow but discernible monetary policy tightening in the U.S. and a firm anchoring of Japanese and core European bond yields suggests significant opportunities to exploit the move in spreads between international markets as well as the shapes of yield curves.  Global investors will continue to get rewarded for blending different country cycles together, especially in sovereign opportunities that may be less familiar in traditional benchmarks. This reflects the value of fundamental research that tracks improved public debt management and institutional transparency and further reform potential (notably in Eastern Europe and parts of Asia).  Credit markets remain supported by central bank balance sheet expansion and purchase programs as well as the abeyance of the energy market scare. If volatility also remains suppressed in this environment, security selection can be fruitful.  The recovery in oil and some other commodity prices has helped to improve the potential for better economic performance in some developing countries such as Brazil and Mexico. Embedded value is often accessible via the currency market.
  3. 3. 3 Challenges Facing Fixed Income Investors: The Subzero-Yield Landscape As of September 30, 2016 Sources: Bloomberg Barclays Global Aggregate Bond Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price. EVOLUTION OF GLOBAL FIXED INCOME MARKETS GOVERNMENT YIELDS 1YR 2YR 3YR 4YR 5YR 6YR 7YR 8YR 9YR 10YR Japan Switzerland Negative Yield Germany Positive Yield Sweden Netherlands France Belgium Spain Italy Australia Canada UK U.S. 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 2010 2011 2012 2013 2014 2015 AVERAGE YIELD TO MATURITY FALLING 0% 5% 10% 15% 20% 25% 30% Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 PROPORTION OF SECURITIES WITH NEGATIVE YIELD INCREASING GLOBAL BONDS GLOBAL BONDS
  4. 4. 4 The Global Monetary Policy Experiment Persists… but Fiscal Expansion Seems More Wish Than Prediction As of September 30, 2016 Sources: Bloomberg Barclays Global Aggregate Bond Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price. CENTRAL BANK BALANCE SHEET (U.S.$ BILLION EQUIVALENTS) STRUCTURAL BUDGET BALANCE -7 -6 -5 -4 -3 -2 -1 0 1 2 2001 2003 2005 2007 2009 2011 2013 2015 2017 %PotentialGDP Advanced Emerging 0 1,000 2,000 3,000 4,000 5,000 6,000 2000 2002 2004 2006 2008 2010 2012 2014 U.S. Eurozone Japan China
  5. 5. 5 Different Government Bond Markets With Different Yield Curves As of September 30, 2016 Sources: Bloomberg Finance L.P. and T. Rowe Price. U.S. TREASURY YIELD CURVE JAPAN GOVERNMENT YIELD CURVE 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y15Y20Y25Y30Y September 30, 2017 (market implied rate) September 30, 2016 September 30, 2015 -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y15Y20Y25Y30Y September 30, 2017 (market implied rate) September 30, 2016 September 30, 2015 Further flattening expected. Steep yield curve to remain.
  6. 6. 6 Europe: A Big Cloud Forming on the Horizon? As of September 30, 2016 Sources: Bloomberg, Bloomberg Barclays Euro Aggregate Corporate Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price. Tapering of QE Program European Elections UK— Article 50 EXPECTED IN 2017 -2% 0% 2% 4% 6% 8% 10% 2007 2008 2009 2010 2011 2012 2013 2014 2015 5-Year Germany Euro Corporate Bonds 5-Year Italy YIELD TO MATURITY OFFERING LITTLE PREMIUM
  7. 7. 7 Moderate Inflation Continues to Support Many Bond Markets As of September 30, 2016 Sources: Bloomberg Finance L.P. and T. Rowe Price. 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Asia Eastern Europe EXPECTED INFLATION IN EASTERN EUROPE AND ASIA BOND MARKET: LOCAL PERFORMANCE 2016 YEAR TO DATE IMF FORECASTS 3.0% 5.7% 5.5% 7.4% 9.4% 5.5% 0% 2% 4% 6% 8% 10% Poland Romania Hungary Malaysia Philippines Thailand
  8. 8. 8 Not All Parts of the Bond Markets Will Follow the Same Pattern in a Rising Rate Environment As of September 30, 2016 Past performance is not a reliable indicator of future performance. Sources: Bloomberg Finance L.P. and T. Rowe Price. MARKET PERFORMANCE WHEN TREASURY YIELDS ROSE 100 BASIS POINTS OR MORE 12-Months Ended U.S. Yield Move U.S. Treasury Bonds U.S. Corporate Bonds U.S. Core Bonds Emerging Markets Corporate Bonds Emerging Markets Hard Currency Bonds U.S. High Yield Bonds Bank Loans Dec. 31, 1999 +179 bps -2.6% -2.0% -0.8% – 24.2% 3.4% 3.6% May 31, 2004 130 -2.6 -0.4 -0.4 3.1 3.1 13.2 7.5 Jun. 30, 2006 120 -1.7 -2.2 -0.8 1.0 4.6 5.1 6.2 Dec. 31, 2009 162 -3.6 18.7 5.9 37.5 28.2 58.9 52.5 Sep. 30, 2013 140 -2.1 -1.6 -1.7 -0.1 -4.3 7.1 5.1 Reference Index 10-Year Treasury Yield Move Bloomberg Barclays U.S. Treasury Bond Index Bloomberg Barclays U.S. Corporate Investment Bond Index Bloomberg Barclays U.S. Aggregate Bond Index J.P. Morgan CEMBI Broad Index J.P. Morgan Emerging Market Bond Global Index J.P. Morgan Global High Yield Index S&P/LSTA Performing Loan Index
  9. 9. 9 Corporate Bonds: Less About Credit Beta and More About Credit Alpha As of September 30, 2016 Sources: Bloomberg Finance L.P. and T. Rowe Price. 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 2007 2008 2009 2010 2011 2012 2013 2014 2015 U.S. High Yield U.S. Investment Grade Euro Investment Grade CREDIT YIELDS NEAR THEIR LOWS IMPACT FROM ENERGY PRICES 10 20 30 40 50 60 70 80 90 100 1103.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 2013 2014 2015 U.S. High Yield Premium Oil Price Option-AdjustedSpread U.S.$perBarrel YieldtoWorst Yield to worst close to lows. Option-adjusted spread vs. oil prices (inverted).
  10. 10. 10 A Preference for European High Yield and Bank Loans As of September 30, 2016 Sources: Bloomberg Finance L.P. and T. Rowe Price. 0% 5% 10% 15% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 U.S. High Yield Euro High Yield U.S. Loans Only DEFAULT RATES: HISTORY AND EXPECTED MOODY’S BASELINE FORECASTS
  11. 11. 11 Near Term, U.S. Dollar Remains Supported As of September 30, 2016 Past performance is not a reliable indicator of future performance. Sources: Bloomberg Finance L.P. and T. Rowe Price. -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40 1.45 1.50 2009 2010 2011 2012 2013 2014 2015 INTEREST RATES DIFFERENTIAL FAVORS U.S. DOLLAR U.S. dollar tends to strengthen vs. euro when U.S. rates increase vs. German rates EUR/USD Spot Germany—U.S. 2-Year Yield Differential
  12. 12. 12 But Emerging Markets Currencies Are Likely to Show Further Appreciation in the Medium Term As of September 30, 2016 Past performance is not a reliable indicator of future performance. Sources: Haver Analytics and T. Rowe Price. -2% -1% 0% 1% 2% 3% 2000 2002 2004 2006 2008 2010 2012 2014 Emerging Markets Average Current Account Balance (% of GDP) Four-Quarters Moving Average IMPROVING CURRENT ACCOUNTS A STRONG APPRECIATION POTENTIAL BASE 100 = DEC. 31, 2007 20 30 40 50 60 70 80 90 100 110 120 2007 2008 2009 2010 2011 2012 2013 2014 2015 Russian Ruble Brazil Real Mexican Peso Indonesian Rupiah DEPRECIATION TREND RECENT APPRECIATION
  13. 13. 13 Finally, Is Volatility the Next Risk on the Horizon? Sources: Bloomberg Barclays, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission. J.P. Morgan and T. Rowe Price. *Merrill Option Volatility Index (MOVE) **CBOE Volatility Index (VIX) 0 10 20 30 40 50 60 70 80 90 2006 2008 2010 2012 2014 2016 IndexLevel 45 70 95 120 145 170 195 220 245 270 2006 2008 2010 2012 2014 2016 IndexLevel TREASURY BOND YIELD VOLATILITY* September 30, 2006–September 30, 2016 S&P 500 OPTION VOLATILITY** September 30, 2006–September 30, 2016 DEUTSCHE BANK CURRENCY VOLATILITY INDEX September 30, 2006–September 30, 2016 10Y Avg. 91 60 10Y Avg. 21 13 10Y Avg. 10 10 5 10 15 20 25 2006 2008 2010 2012 2014 2016 IndexLevel FX Volatiltiy IndexFX Volatility Index
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