For 2020, we expect global growth to remain resilient on the back of steady US growth, improving domestic conditions in the eurozone and an acceleration in emerging market (EM) growth momentum. Sustained monetary policy accommodation by the Fed and ECB intended to truncate downside growth risks and engineer a pick-up in inflation momentum, combined with receding fears over Brexit and US-China trade tensions, should serve to buoy global financial market sentiment, especially in a period of mounting geopolitical risk. Ultimately, a benign global macro backdrop is favorable for spread sectors and suggests further outperformance versus developed market (DM) government bonds as we move further into the New Year. Here we provide a summary of the key drivers behind our global outlook, how we’re positioned in broad market portfolios and a more detailed description of where we see value across global fixed-income markets.

KEY DRIVERS
US: Economic Momentum Remains Stable

We expect 2019 growth results for the US to come in between 2.0% and 2.25%. With consumer spending growth looking decent, there is some upside risk for 2019 relative to our forecast. Trade war concerns continue, but as of yet, these are fears more than reality, as trade has actually been a net positive to US growth in 2019. The only downside risk for 2019 growth lies in inventories, but this is merely a transitory effect.

Nowhere is there actual weakness in the US economic data. “Soft data” indicators suggest manufacturing weakness, but hard data on the factory sector indicate this weakness to have occurred early in 2019, with a distinct stabilization or improvement in factory indicators lately. We expect this better factory tone to continue into next year. Consequently, we project 2020 growth for the US to be only slightly slower than in 2019, say right around 2%.

Regarding the Fed, we maintain the view that Chair Jerome Powell’s focus on below-target inflation, as evidenced by his statement in the most recent Federal Open Market Committee (FOMC) meeting, leaves the door open to future rate cuts to further support inflation. While Powell did not signal that any such action is particularly imminent, nor is it in the FOMC’s current base case, the meeting’s dovish tilt implied openness to such future action.

Europe: Signs of Green Shoots

For 2020, we continue to see a moderate growth rebound in the eurozone overall (around 1.2%), mainly driven by somewhat better outcomes in Germany and Italy. While this is largely unchanged from last quarter, our views have developed somewhat on the political and monetary policy front. In Italy, a fractious coalition will face existential risks during regional elections in 1Q20, creating downside risks to our growth rebound assumption, while in Germany, political uncertainty could lead to policy inertia at the national level. However, on the European level, Germany assumes the EU presidency in the latter half of 2020, so we expect substantial negotiations—and possibly progress—on a number of outstanding issues in the run-up (e.g., capital markets union, common market for services, deposit reinsurance scheme).

On monetary policy, the transition at the helm of the ECB will provide for a period of reflection, and the formal monetary policy strategy review should be underway shortly and conclude before the end of 2020. We believe that the hurdle for the ECB to cut rates further has increased since last quarter and is now quite high as the economy seems to be through the worst—in fact, ECB President Christine Lagarde acknowledged the data improvement and reduced downside risks in her first press conference as President—and the Fed may have stopped easing. That said, a rate cut is still more likely than a hike for the ECB (but neither is in our near-term baseline).

In the UK, financial markets will continue to remain volatile and react to trade deal headlines; we believe that the domestic macro outlook for 2020 looks somewhat rosier. Having ground to a virtual standstill in the second half of 2019, growth is set to rebound to around 1.5%, boosted by extra government spending and a partial resumption in business investment. Using the playbook from the last three and a half years, we are fully expecting continued investor angst in the run up to what could be yet another last minute Brexit deal with inevitable compromises from both sides. Despite this uncertainty, Western Asset remains constructive on UK corporate bonds and the pound.

Emerging Markets: Poised to Grow

EM growth is poised to accelerate to a three-year high of 4.6% in 2020, based on the latest IMF forecasts. With the exception of China, most core EM economies are expected to stage a rebound, thanks to aggressive policy easing by EM central banks as well as reduced US-China trade tensions. Of note is the abatement of inflation risk across EM countries. Indeed, valuation wise, real yields in EM remain compelling, currently averaging roughly 170 basis points (bps) above those in DM. From a technical perspective, we do not view EM as excessively over-owned, as compared with the period heading into the taper tantrum. Our EM convictions center on select EM countries with strong fundamentals and institutions, where structural reforms and policy flexibility should pave the way for a growth bounce. The focus list centers on high-grade countries including Indonesia and Russia as well as select defensive credits in the growing Gulf sovereign complex. In crossover strategies, EM credits offer diversification appeal when compared against “quasi risk free” valuations in DM credits. To be sure, the overriding macro uncertainty is renewed pressure on EM growth if trade and/or geopolitical tensions escalate.

Oil Markets: Geopolitical Risk Once Again on the Rise

The recent flare up in Middle East hostilities—first, a targeted US air strike against a senior Iranian military officer followed by a retaliatory response by Iran with warnings of serious reprisal in the event of further US provocation—has priced new risk premiums into global oil markets. In contrast to oil price behavior following the series of drones strikes against Saudi processing facilities during 3Q19, this development has the potential to materially alter supply and demand fundamentals over the near term. Following these events, Brent and WTI spot prices were up 3.6% and 3.4%, respectively, but have since pulled back on more measured rhetoric between both sides. Longer-dated WTI prices were up less, 0.5%, and flat for 2021 and 2022 averages, respectively, as the market remains concerned about ample oil supplies, weakening demand longer term, and continued producer hedging of out-year production.

While there is a wide range of possible scenarios going forward, we believe WTI oil prices will remain elevated in the $60-$65 per barrel range to account for the additional geopolitical risk premiums. We would expect a more severe move higher in both short-dated and longer-dated crude should further hostilities materially impact regional supplies in Saudi Arabia or Iraq given the countries are the second and fifth largest oil producers in the world, respectively.

Prior to this development, the crude market in 2020 was shaping up to be relatively balanced—resilient oil demand growth, moderating US production growth, announced additional OPEC production cuts and continued geopolitical risks all supportive of oil prices. Concerns over trade tensions and weaker economic growth have since subsided on the back of the “phase one” US/China agreement and the signing of the US-Mexico-Canada (USMCA) agreement which provides a more reasonable oil demand growth backdrop.

While WTI prices over the short term are expected to be elevated (and volatile) given the supply-side risks, we would expect prices to return to the $50-$55 per barrel range over the medium to longer term given lower demand growth from slowing forward economic activity. The rise in near-dated oil prices should enable US producers to extend hedge protections further into 2020 and 2021, providing a short-term boost to cash flows.

US: Economic Momentum Remains Stable

We expect 2019 growth results for the US to come in between 2.0% and 2.25%. With consumer spending growth looking decent, there is some upside risk for 2019 relative to our forecast. Trade war concerns continue, but as of yet, these are fears more than reality, as trade has actually been a net positive to US growth in 2019. The only downside risk for 2019 growth lies in inventories, but this is merely a transitory effect.

Nowhere is there actual weakness in the US economic data. Double O Small Icon

Nowhere is there actual weakness in the US economic data. “Soft data” indicators suggest manufacturing weakness, but hard data on the factory sector indicate this weakness to have occurred early in 2019, with a distinct stabilization or improvement in factory indicators lately. We expect this better factory tone to continue into next year. Consequently, we project 2020 growth for the US to be only slightly slower than in 2019, say right around 2%.

Regarding the Fed, we maintain the view that Chair Jerome Powell’s focus on below-target inflation, as evidenced by his statement in the most recent Federal Open Market Committee (FOMC) meeting, leaves the door open to future rate cuts to further support inflation. While Powell did not signal that any such action is particularly imminent, nor is it in the FOMC’s current base case, the meeting’s dovish tilt implied openness to such future action.

Europe: Signs of Green Shoots

For 2020, we continue to see a moderate growth rebound in the eurozone overall (around 1.2%), mainly driven by somewhat better outcomes in Germany and Italy. While this is largely unchanged from last quarter, our views have developed somewhat on the political and monetary policy front. In Italy, a fractious coalition will face existential risks during regional elections in 1Q20, creating downside risks to our growth rebound assumption, while in Germany, political uncertainty could lead to policy inertia at the national level. However, on the European level, Germany assumes the EU presidency in the latter half of 2020, so we expect substantial negotiations—and possibly progress—on a number of outstanding issues in the run-up (e.g., capital markets union, common market for services, deposit reinsurance scheme).

On monetary policy, the transition at the helm of the ECB will provide for a period of reflection, and the formal monetary policy strategy review should be underway shortly and conclude before the end of 2020. We believe that the hurdle for the ECB to cut rates further has increased since last quarter and is now quite high as the economy seems to be through the worst—in fact, ECB President Christine Lagarde acknowledged the data improvement and reduced downside risks in her first press conference as President—and the Fed may have stopped easing. That said, a rate cut is still more likely than a hike for the ECB (but neither is in our near-term baseline).

In the UK, financial markets will continue to remain volatile and react to trade deal headlines; we believe that the domestic macro outlook for 2020 looks somewhat rosier. Having ground to a virtual standstill in the second half of 2019, growth is set to rebound to around 1.5%, boosted by extra government spending and a partial resumption in business investment. Using the playbook from the last three and a half years, we are fully expecting continued investor angst in the run up to what could be yet another last minute Brexit deal with inevitable compromises from both sides. Despite this uncertainty, Western Asset remains constructive on UK corporate bonds and the pound.

Global Outlook Chart
Estimated Growth Rates
Emerging Markets: Poised to Grow

EM growth is poised to accelerate to a three-year high of 4.6% in 2020, based on the latest IMF forecasts. With the exception of China, most core EM economies are expected to stage a rebound, thanks to aggressive policy easing by EM central banks as well as reduced US-China trade tensions. Of note is the abatement of inflation risk across EM countries. Indeed, valuation wise, real yields in EM remain compelling, currently averaging roughly 170 basis points (bps) above those in DM. From a technical perspective, we do not view EM as excessively over-owned, as compared with the period heading into the taper tantrum. Our EM convictions center on select EM countries with strong fundamentals and institutions, where structural reforms and policy flexibility should pave the way for a growth bounce. The focus list centers on high-grade countries including Indonesia and Russia as well as select defensive credits in the growing Gulf sovereign complex. In crossover strategies, EM credits offer diversification appeal when compared against “quasi risk free” valuations in DM credits. To be sure, the overriding macro uncertainty is renewed pressure on EM growth if trade and/or geopolitical tensions escalate.

Oil Markets: Geopolitical Risk Once Again on the Rise
We believe WTI oil prices will remain elevated in the $60-$65 per barrel range. Double O Icon

The recent flare up in Middle East hostilities—first, a targeted US air strike against a senior Iranian military officer followed by a retaliatory response by Iran with warnings of serious reprisal in the event of further US provocation—has priced new risk premiums into global oil markets. In contrast to oil price behavior following the series of drones strikes against Saudi processing facilities during 3Q19, this development has the potential to materially alter supply and demand fundamentals over the near term. Following these events, Brent and WTI spot prices were up 3.6% and 3.4%, respectively, but have since pulled back on more measured rhetoric between both sides. Longer-dated WTI prices were up less, 0.5%, and flat for 2021 and 2022 averages, respectively, as the market remains concerned about ample oil supplies, weakening demand longer term, and continued producer hedging of out-year production.

While there is a wide range of possible scenarios going forward, we believe WTI oil prices will remain elevated in the $60-$65 per barrel range to account for the additional geopolitical risk premiums. We would expect a more severe move higher in both short-dated and longer-dated crude should further hostilities materially impact regional supplies in Saudi Arabia or Iraq given the countries are the second and fifth largest oil producers in the world, respectively.

Prior to this development, the crude market in 2020 was shaping up to be relatively balanced—resilient oil demand growth, moderating US production growth, announced additional OPEC production cuts and continued geopolitical risks all supportive of oil prices. Concerns over trade tensions and weaker economic growth have since subsided on the back of the “phase one” US/China agreement and the signing of the US-Mexico-Canada (USMCA) agreement which provides a more reasonable oil demand growth backdrop.

While WTI prices over the short term are expected to be elevated (and volatile) given the supply-side risks, we would expect prices to return to the $50-$55 per barrel range over the medium to longer term given lower demand growth from slowing forward economic activity. The rise in near-dated oil prices should enable US producers to extend hedge protections further into 2020 and 2021, providing a short-term boost to cash flows.

The Big Picture

Developed Market Rates: Relative Value by Region

CANADA: The Canadian yield curve is trading through money market rates, reflecting downside risks. However, this will limit interest in Canadian fixed-income and likely cap returns. Longer-dated bonds do not look as attractive as they had earlier; however, they still offer value relative to the US.
US: We don’t expect any Fed hikes until realized inflation is above the Fed’s 2% target on a sustained basis. We will maintain a long duration position with diversified exposure across the UST curve which can also act as ballast against spread risk.
UK: Should the UK and EU reach some form of agreement on Brexit, we expect higher gilt yields and a stronger GBP. Although the UK election outcome is market friendly in the near term, the gilt curve could steepen as fiscal spending needs related to Brexit materialize.
EUROPE: We view the ECB’s asset purchase program as driving further yield compression. That said, the lower intensity (at €20 billion per month) implies that the downward pull for bond yields is less strong than in previous iterations. As the growth picture is improving on the margin, we still view global bonds as overvalued.
JAPAN: We expect a steeper yield curve especially in the super-long end as the BoJ is likely to reduce JGB purchases.
AUSTRALIA: We are actively managing duration given unresolved external risks. We are maintaining curve flattening positions as ballast to our overweight credit position and rotating between high-grade sectors of semi-government, supranational, sovereigns and agencies; we currently favor semi-governments.
See Relative Value by Sector section for the Emerging Markets outlook.
US We expect 2019 US growth to come in between 2.0%-2.25%. “Soft data” indicators suggest manufacturing weakness, but the hard data on the factory sector indicate this weakness to have occurred early in 2019, with a distinct stabilization or improvement in factory indicators lately. We expect this better factory tone to continue in 2020 and project 2020 growth to be around 2.0%.
Canada The economy is bumping against capacity constraints while risks to US trade should diminish. The business cycle is likely to extend further with inflation around target, keeping Bank of Canada policy rates on hold.  Policy will still be more reactive on negative surprises, but these are likely to be exogenous shocks.
Europe For 2020, we continue to see a moderate growth rebound in the eurozone overall, mainly driven by somewhat better outcomes in Germany and Italy. We believe that the hurdle for the ECB to cut further has increased since last quarter and is now quite high as the economy seems to be through the worst and the Fed may have stopped easing. That said, a rate cut is still more likely than a hike for the ECB (but neither is in our near-term baseline).
UK We expect a Brexit "deal" to occur in 1Q20 in light of the substantial majority the Conservatives won at the elections. In terms of growth outlook, this implies a reduction of uncertainty that should bolster investment in 2020 and we are in the process of revising our growth outlook up to around 1.5%. We expect the Bank of England to start hiking next year at a very measured pace.
Japan We maintain a constructive view on the Japanese economy, driven by consumer spending, business investment and potential fiscal stimulus. Negative effects of a consumption tax increase are expected to be limited. On monetary policy, we expect the BoJ to maintain its accommodative policy for some time to meet its 2% inflation goal. No further easing is our base case scenario.
Australia Government spending and exports contributed heavily to growth in 2019, but we believe consumer activity will step up going forward. Confidence has improved on recovery in housing prices and disposable income. Government plans for fiscal stimulus remain on hold. Another RBA cash rate cut has to be considered in 1H20, but we believe that QE won’t be required and see little benefit from such a strategy.

Relative Value by Sector

IG Corporate Credit
US
Outlook We remain a better holder of risk as we start the new year given continued accommodative central bank policies and prevalent negative yields around the world.  US IG credit index spreads started 4Q19 at 111 bps and continued to grind tighter, reaching 91 bps in mid-December 2019. We maintain a cautious bias toward sectors such as food & beverage, healthcare/pharmaceuticals and automotive.  
Relative Value +/– Our focus continues to be on banking, energy and metals & mining; these are sectors where positive fundamental trends remain intact, which exhibit the least sensitivity to tariff-related risk and where we are likely to see further uplift from the ratings agencies.
Europe
Outlook European IG credit fundamentals remain solid in most sectors, with the exception of autos and retail. The technical backdrop is supportive, with negative government bond yields and the re-start of corporate bond purchases by the ECB fueling demand for credit. Valuations are compelling given the low rate backdrop but still look tight on a historical basis.
Relative Value +/- Our positioning is cautious overall. We prefer financials and REITs over utilities and cyclical names.
Australia
Outlook Fundamentals remain strong as management retains a conservative attitude to balance sheets alongside solid profitability. Limited issuance and maturities expected in 2020 should also assist on the technical front.
Relative Value + We are overweight to the sector but holding a short duration focus to manage spread risk. Our sector biases remain in financials, REITS and regulated utilities.
High-Yield (HY) Corporate Credit
US
Outlook Given the positive fundamental backdrop, strong technical picture and supportive Fed, HY spreads continue to compress and are broadly approaching fair value. We remain cautious on the lower quality segment of the market due to concerns over global growth, geopolitical tensions, election risk, and late cycle access to capital availability.
Relative Value +/- We see value in asset rich subsectors and companies with clear access to capital. We are selectively participating in the primary market where positive catalysts are apparent. We remain underweight CCCs and below-rated paper.
Europe
Outlook A weaker European economic backdrop is beginning to impact fundamentals. Technicals remain supportive given negative rates; however, valuations are less compelling. Primary issuance is mainly focused on refinancing and BB/B rated deals. We expect this trend to continue, resulting in less CCC issuance.
Relative Value +/– Increasingly, more companies are being assigned a negative credit rating outlook and issuer dispersion is continuing. Therefore we remain opportunistic to new issues and secondary market opportunities.
Bank Loans
US
Outlook Rates stability or a dovish Fed should drive retail flows to the asset class.  Loans offer attractive carry with market value upside driven by ramping CLO vehicles and supply technicals. HY crossover and multi-asset credit accounts have been increasing allocations to loans due to the relative attractiveness, which has helped to drive single-B prices higher.
Relative Value + The market rallied in December as investors with high cash balances looked at a light 1Q20 supply calendar. We continue to see opportunity in single-Bs as the risk of repricing in above-par high quality loans will lead investors to reallocate into more attractively priced single-B secondary names.
Collateralized Loan Obligations (CLOs)
US
Outlook Despite recent tightening, BBB/BB CLOs still screen cheap relative to loans/HY while AAA/AA CLOs appear cheap relative to other comparably rated products. Robust supply technicals should keep AAA spreads range bound. BBB/BB spreads will take their cues from macro and HY/loan price movement. We expect growing tiering in prices in lower-rated CLOs in the secondary versus primary markets, which will create opportunities.
Relative Value + We prefer front-end AAAs and favor a slight barbell against longer new-issue AAAs. Within lower mezzanine tranches, opportunities exist in the secondary market. New-issue deals will likely be structured at tighter levels than the market, but should provide nice carry opportunities yielding in the 9% area.
Structured Credit
Agency MBS
Outlook We are constructive on mortgages due to locally wide spread levels and the expectation that central banks will remain accommodative.
Relative Value +/– We are positive on MBS versus USTs and favor lower coupons and agency CMBS.
Non-Agency Residential MBS (RMBS)
Outlook We are constructive on housing fundamentals and expect modest home price growth over the coming years, with limited downside risks as housing appears reasonably valued and supported. Credit underwriting standards are historically high, making the quality of new loan production strong.
Relative Value + We are positive on the credit risk of GSEs (Fannie Mae and Freddie Mac) and recently issued non-agency loans as well as re-performing loans and securities.
Non-agency Commercial MBS (CMBS)
Outlook We remain constructive on the CMBS market, due to broadly positive commercial real estate fundamentals and a favorable economic outlook; we expect the fundamental outlook to be uneven across property types and markets.
Relative Value + We are positive on short-duration, well-structured single-borrower securitizations and loans; in conduit deals we see better value in AAA rated bonds.
Asset-Backed Securities (ABS)
Outlook We remain constructive on consumer fundamentals and the current state of leverage; opportunities remain in well-protected, off-the-run sectors, which offer attractive risk/return.
Relative Value +/– We are constructive on off-the-run senior high-quality ABS sectors, such as FFELP student loans, auto floor-plan and rental car.
Inflation-Linked
US
Outlook Breakeven inflation rates remain well below Fed targets. Each iteration of FOMC inflation framework discussions has a diminishing impact on breakevens. With year-over-year core CPI now declining, we still think TIPS will struggle to attract substantial inflows. Over time, however, there is scope for longer-term inflation expectations to move higher.
Relative Value +/– In the near term, we prefer to maintain an overweight in US real yields combined with tactical positioning in nominal bonds to manage overall duration exposure.
Europe
Outlook European breakeven spreads remain at low levels, alongside most DM breakeven spreads. We expect headline inflation to average 1.20% in 2020, which is below the level priced in the swap and cash markets over the medium term. At the margin, ECB purchases on index-linked bonds should be supportive.
Relative Value + In index-linked and global portfolios, we are long French and Italian breakeven spreads.
Japan
Outlook Japanese breakeven inflation spreads have fallen to around 0.1%, which are even below the floor option values.  We expect inflation in Japan to rise gradually toward 1.0% in 2020 on the back of the tight labor market. Therefore, we believe that Japanese inflation-linked bonds are significantly undervalued.
Relative Value + We maintain an overweight in Japanese real yields against nominal yields.
Municipals
US
Outlook We continue to see good fundamentals in the overall municipal market due to a number of factors, including strong market technicals, low unemployment, improving tax revenues and modest budgetary spending proposals. We see valuations as fair to full value at the short end of the curve while better value can be found in the intermediate and longer maturity range.
Relative Value + We are focused on income with an emphasis on lower investment-grade issuers within transportation, industrial development and water & sewer sectors, an opportunistic eye to below-investment-grade issuers, and our curve position remains centered on intermediate and longer maturities.
EM Debt
EM Sovereigns (USD)
Outlook From a supply standpoint, the bulk of EM USD net issuance continues to come from sovereigns such as Gulf Cooperation Council (GCC) and Frontier countries, increasing the sectors visibility and relevance. We remain vigilant with regard to the increasing global trend of populism and emphasize starting financial conditions in assessing a sovereign’s ability to weather political and fiscal challenges.
Relative Value + Select IG-rated EM USD-denominated sovereigns remain attractive from a carry standpoint, while BBB rated sovereigns appear more fully valued. Performance of HY-rated and Frontier sovereigns may diverge based on issuance needs and election dynamics.
EM Local Currency
Outlook EM real yields and differentials versus DM are supportive of the asset class and have scope to compress. Diminishing impact of US fiscal stimulus and the re-introduction of stimulus in China augur well for the end of US growth exceptionalism. In our view, these factors should be positive for EM local currency debt. Elevated FX volatility remains a headwind for the asset class.
Relative Value +/- We currently find local rates to be the most attractive part of the EM local currency universe given high real yields and a more dovish outlook for EM central banks. We favor the local bonds of stable countries with moderate inflation, including Indonesia, Brazil and Russia.
EM Corporates
Outlook We continue to view higher quality EM corporates as being defensive within the global credit universe given low leverage and conservative balance sheet management. While the overall market shows robust bond issuance, EM corporate net issuance ex-China remains very low, creating positive technicals for the asset class.
Relative Value + EM IG corporates are an attractive complement to US IG allocations given higher spreads, shorter duration and more favorable technicals. For HY corporates, we have a preference for BBs in less financing-sensitive sovereigns and those generating revenues in hard currency.
Outlook Relative Value
IG Corporate Credit
US We remain a better holder of risk as we start the new year given continued accommodative central bank policies and prevalent negative yields around the world.  US IG credit index spreads started 4Q19 at 111 bps and continued to grind tighter, reaching 91 bps in mid-December 2019. We maintain a cautious bias toward sectors such as food & beverage, healthcare/pharmaceuticals and automotive.   +/– Our focus continues to be on banking, energy and metals & mining; these are sectors where positive fundamental trends remain intact, which exhibit the least sensitivity to tariff-related risk and where we are likely to see further uplift from the ratings agencies.
Europe European IG credit fundamentals remain solid in most sectors, with the exception of autos and retail. The technical backdrop is supportive, with negative government bond yields and the re-start of corporate bond purchases by the ECB fueling demand for credit. Valuations are compelling given the low rate backdrop but still look tight on a historical basis. +/- Our positioning is cautious overall. We prefer financials and REITs over utilities and cyclical names.
Australia Fundamentals remain strong as management retains a conservative attitude to balance sheets alongside solid profitability. Limited issuance and maturities expected in 2020 should also assist on the technical front. + We are overweight to the sector but holding a short duration focus to manage spread risk. Our sector biases remain in financials, REITS and regulated utilities.
High-Yield (HY) Corporate Credit
US Given the positive fundamental backdrop, strong technical picture and supportive Fed, HY spreads continue to compress and are broadly approaching fair value. We remain cautious on the lower quality segment of the market due to concerns over global growth, geopolitical tensions, election risk, and late cycle access to capital availability. +/- We see value in asset rich subsectors and companies with clear access to capital. We are selectively participating in the primary market where positive catalysts are apparent. We remain underweight CCCs and below-rated paper.
Europe A weaker European economic backdrop is beginning to impact fundamentals. Technicals remain supportive given negative rates; however, valuations are less compelling. Primary issuance is mainly focused on refinancing and BB/B rated deals. We expect this trend to continue, resulting in less CCC issuance. +/– Increasingly, more companies are being assigned a negative credit rating outlook and issuer dispersion is continuing. Therefore we remain opportunistic to new issues and secondary market opportunities.
Bank Loans
US Rates stability or a dovish Fed should drive retail flows to the asset class.  Loans offer attractive carry with market value upside driven by ramping CLO vehicles and supply technicals. HY crossover and multi-asset credit accounts have been increasing allocations to loans due to the relative attractiveness, which has helped to drive single-B prices higher. + The market rallied in December as investors with high cash balances looked at a light 1Q20 supply calendar. We continue to see opportunity in single-Bs as the risk of repricing in above-par high quality loans will lead investors to reallocate into more attractively priced single-B secondary names.
Collateralized Loan Obligations (CLOs)
US Despite recent tightening, BBB/BB CLOs still screen cheap relative to loans/HY while AAA/AA CLOs appear cheap relative to other comparably rated products. Robust supply technicals should keep AAA spreads range bound. BBB/BB spreads will take their cues from macro and HY/loan price movement. We expect growing tiering in prices in lower-rated CLOs in the secondary versus primary markets, which will create opportunities. + We prefer front-end AAAs and favor a slight barbell against longer new-issue AAAs. Within lower mezzanine tranches, opportunities exist in the secondary market. New-issue deals will likely be structured at tighter levels than the market, but should provide nice carry opportunities yielding in the 9% area.
Structured Credit
Agency MBS We are constructive on mortgages due to locally wide spread levels and the expectation that central banks will remain accommodative. +/– We are positive on MBS versus USTs and favor lower coupons and agency CMBS.
Non-Agency Residential MBS (RMBS) We are constructive on housing fundamentals and expect modest home price growth over the coming years, with limited downside risks as housing appears reasonably valued and supported. Credit underwriting standards are historically high, making the quality of new loan production strong. + We are positive on the credit risk of GSEs (Fannie Mae and Freddie Mac) and recently issued non-agency loans as well as re-performing loans and securities.
Non-agency Commercial MBS (CMBS) We remain constructive on the CMBS market, due to broadly positive commercial real estate fundamentals and a favorable economic outlook; we expect the fundamental outlook to be uneven across property types and markets. + We are positive on short-duration, well-structured single-borrower securitizations and loans; in conduit deals we see better value in AAA rated bonds.
Asset-Backed Securities (ABS) We remain constructive on consumer fundamentals and the current state of leverage; opportunities remain in well-protected, off-the-run sectors, which offer attractive risk/return. +/– We are constructive on off-the-run senior high-quality ABS sectors, such as FFELP student loans, auto floor-plan and rental car.
Inflation-Linked
US Breakeven inflation rates remain well below Fed targets. Each iteration of FOMC inflation framework discussions has a diminishing impact on breakevens. With year-over-year core CPI now declining, we still think TIPS will struggle to attract substantial inflows. Over time, however, there is scope for longer-term inflation expectations to move higher. +/– In the near term, we prefer to maintain an overweight in US real yields combined with tactical positioning in nominal bonds to manage overall duration exposure.
Europe European breakeven spreads remain at low levels, alongside most DM breakeven spreads. We expect headline inflation to average 1.20% in 2020, which is below the level priced in the swap and cash markets over the medium term. At the margin, ECB purchases on index-linked bonds should be supportive. + In index-linked and global portfolios, we are long French and Italian breakeven spreads.
Japan Japanese breakeven inflation spreads have fallen to around 0.1%, which are even below the floor option values.  We expect inflation in Japan to rise gradually toward 1.0% in 2020 on the back of the tight labor market. Therefore, we believe that Japanese inflation-linked bonds are significantly undervalued. + We maintain an overweight in Japanese real yields against nominal yields.
Municipals
US We continue to see good fundamentals in the overall municipal market due to a number of factors, including strong market technicals, low unemployment, improving tax revenues and modest budgetary spending proposals. We see valuations as fair to full value at the short end of the curve while better value can be found in the intermediate and longer maturity range. + We are focused on income with an emphasis on lower investment-grade issuers within transportation, industrial development and water & sewer sectors, an opportunistic eye to below-investment-grade issuers, and our curve position remains centered on intermediate and longer maturities.
EM Debt
EM Sovereigns (USD) From a supply standpoint, the bulk of EM USD net issuance continues to come from sovereigns such as Gulf Cooperation Council (GCC) and Frontier countries, increasing the sectors visibility and relevance. We remain vigilant with regard to the increasing global trend of populism and emphasize starting financial conditions in assessing a sovereign’s ability to weather political and fiscal challenges. + Select IG-rated EM USD-denominated sovereigns remain attractive from a carry standpoint, while BBB rated sovereigns appear more fully valued. Performance of HY-rated and Frontier sovereigns may diverge based on issuance needs and election dynamics.
EM Local Currency EM real yields and differentials versus DM are supportive of the asset class and have scope to compress. Diminishing impact of US fiscal stimulus and the re-introduction of stimulus in China augur well for the end of US growth exceptionalism. In our view, these factors should be positive for EM local currency debt. Elevated FX volatility remains a headwind for the asset class. +/- We currently find local rates to be the most attractive part of the EM local currency universe given high real yields and a more dovish outlook for EM central banks. We favor the local bonds of stable countries with moderate inflation, including Indonesia, Brazil and Russia.
EM Corporates We continue to view higher quality EM corporates as being defensive within the global credit universe given low leverage and conservative balance sheet management. While the overall market shows robust bond issuance, EM corporate net issuance ex-China remains very low, creating positive technicals for the asset class. + EM IG corporates are an attractive complement to US IG allocations given higher spreads, shorter duration and more favorable technicals. For HY corporates, we have a preference for BBs in less financing-sensitive sovereigns and those generating revenues in hard currency.