Western Asset expects that the second half of the year should see very strong growth in global GDP as the world economy reopens. That stated, we are cautious about extrapolating short-term cyclical boosts into a presumption of a higher secular trend rate of growth or inflation. The secular challenges that have kept US and global growth to a moderate pace at best over the last several decades persist. These include the stagnation of Western societies’ middle-class wages, aging demographics and rising global debt burdens. Moreover, the small and medium-sized business destruction in many countries not seen since the Great Depression may take years to repair. Given this backdrop, Western Asset expects central banks to remain extraordinarily accommodative for the foreseeable future. We aim to position our portfolios to withstand further market volatility, yet remain flexible enough to capture value opportunities as they appear. Here, we provide a summary of the key drivers behind our global outlook and describe where we see value across global fixed-income markets.

KEY DRIVERS
The Big Picture

Developed Market Rates: Relative Value by Region

CANADA: Provincial and corporate spreads are expected to remain near current narrow levels as the Canadian economy reopens. While longer-term bond yields may still move higher, we don’t expect the two rate hikes by the BoC that are already priced into the 2022 curve.
US: We expect yields to remain in the trading range of the last quarter, with a bias toward the lower end.
UK: As the UK moves past the pandemic, the strong coordination between monetary and fiscal policy might soften a bit. We continue to be agnostic on the currency but could see downside risks emerge from a trade and capital flow perspective, especially if the BoE stays dovish.
EUROPE: Lower ECB support in combination with a rebounding economy is likely to lead to higher bond yields but we do not see a strong argument for (or against) a significant change in spreads.
JAPAN: We expect higher yields on the long end. As the BoJ keeps reducing JGB purchases with maintaining the yield-curve control frame-work, yields up to the 10-year are likely to be kept at low levels, while yields beyond the 10-year may move higher.
AUSTRALIA: The RBA continues to stress “patience” and is holding the yield curve at historic lows, despite the strong bounce in the economy. We are marginally overweight the high-grade supranational debt sector which currently offers greater value versus semi-government bonds.
See Relative Value by Sector section for the Emerging Markets outlook.
US We expect growth in the service sectors to continue to disappoint relative to consensus expectations; meanwhile, growth in manufacturing and construction sectors will be muted, as the recovery there is already complete.
Canada The recovery downshifted early in Q2 due to restrictions, but growth was better than expected. Rate hike expectations have accelerated, though we think the BoC will emphasize patience as core inflation remains below the top of the 1% to 3% range under circumstances of uncertainty.
Europe National fiscal support to continue into next year, albeit at a slowing pace compared to this year, increasingly requiring economies to build momentum. We see NGEU support slowly building over the next few years, while increasing the pool of supranational safe-haven assets. Monetary support is likely to slow as the ECB may reduce asset purchases into the ongoing rebound, but the Strategy Review is a focal point over the next months.
UK The UK is very likely to end pandemic restrictions in Q3 but we expect only a comparatively limited marginal impact on the economy from that. The main risks are a higher inflation trajectory than currently envisaged by the Bank of England driven by a rapid absorption of currently furloughed workers and continued uncertainty in the UK’s relationship with continental Europe.
Japan We expect that the Japanese economy will continue to recover as the vaccine rollouts have finally accelerated. The BoJ’s commitment to the easy monetary policy and the Japanese government’s flexible fiscal stance to support the recovery remain intact.
Australia As a result of strict Covid-related restrictions, the economy has outperformed most developed countries with both employment and growth now above pre-pandemic levels. A delay in securing vaccines could crimp the current pace of growth. The RBA and government remain committed to supporting the economy through super easy monetary policy and fiscal support until inflation and, importantly, wage growth returns.

Relative Value by Sector