The key to an improved tone and more stability in fixed-income markets is a moderation in inflation. Our base case is that supply chains will slowly begin to normalize. This trend, combined with the Federal Reserve (Fed) and other major central banks around the world tightening monetary policy along with negative real incomes slowing consumption, should see inflation moderate. We anticipate inflationary pressures will peak in 3Q22 and decline into 2023. While global central banks are expected to raise interest rates further in the short term, we believe more aggressive action is already anticipated by the markets. Fundamental headwinds to global growth and inflation remain. These include the reduction of global fiscal stimulus, the withdrawal of monetary policy accommodation and the persistence of secular-related headwinds such as global debt burdens, aging demographics and technology displacement. As growth and inflation moderate and the risks surrounding central bank policy become more balanced, so too should the market environment for fixed-income investors. Not only may the rise in government yields abate, but lower volatility could also lead investors to reengage in fixed-income spread sectors, especially given current valuations. Here, we provide a summary of the key drivers behind our global outlook and describe where we see value across global fixed-income markets.

The Big Picture

Global Market Rates: Relative Value by Region

CANADA: Corporate spreads continued to widen and are pricing in a mild recession in the face of tighter monetary policy. We expect spreads to narrow as inflation declines limit BoC tightening. Provincials have remained near Q1 wides and are attractive here.
US: We expect the Fed will moderate its hawkish stance as inflation downshifts and growth slows. Front-end rates should remain volatile and vulnerable to higher inflation prints, but rates in the longer end have repriced to fair levels and should be supported in a slower global growth scenario.
UK: We feel that the market is still expecting too much in terms of hikes, and therefore gilts should outperform.
EUROPE: We expect a moderate decline in yields and spreads, especially if the ECB delivers a credible anti-fragmentation tool as planned.
CHINA: We expect rates to remain low with long-term rates well anchored by targeted tightening and a universal easing approach toward all macroeconomic levers.
JAPAN: We expect a steeper yield curve with stable yields up to the 10-year.
AUSTRALIA: We are focused on the 10-year bond but we see value across the curve, as we expect both that the RBA will remain balanced and that it won’t move at the speed and magnitude that the market has now factored in. Semi-government bonds are still looking fully priced, whereas high-grade supranational debt is looking attractive.
See Relative Value by Sector section for the Emerging Markets outlook.
US The economic outlook has deteriorated due to the effects of rising prices on consumer and business finances. A more aggressive-than-expected Fed hiking regimen, along with the financial markets’ response to those pronouncements, have further clouded the outlook. Growth of 1% or less in coming quarters seems likely.
Canada Expectations for Bank of Canada (BoC) tightening have risen to well above 3% by year-end. However, the evident turn in the rate-sensitive sectors of housing and durables indicate rates may peak at a lower rate. A sustained bond rally may wait for Q4 declines in employment or actual prices. In the meantime, fixed-income yields are attractive on long-term measures.
Europe At this point, the degree of rate hikes on the continent is far from certain. This will depend on the situation in Ukraine and the inflation trajectory but also on forthcoming fiscal support, which could put a floor under the downside risks to growth. The risk of energy rationing in key eurozone economies is a prominent risk.
UK The UK’s faster rebound has also led to a faster hiking cycle and earlier concerns about the strength of the economy. We believe that the BoE’s hiking cycle is likely to run out of steam sooner rather than later as inflation and fiscal pressures weaken household demand.
China We expect growth to come in between 4% and 5% in 2022; with policymakers focused on stability with some growth upside, the COVID-19 omicron variant continues to challenge China’s approach to Covid.
Japan We expect that the Japanese economy will continue to grow at 1.5%-2.5% in 2022 and 2023. The Bank of Japan (BoJ) will likely maintain the current monetary accommodation unlike other developed market (DM) central banks. The BoJ will continue to place more focus on growth as long as inflation pressure remains relatively lower.
Australia The Reserve Bank of Australia (RBA) joined the central bank attack on inflation in May and has since moved the cash rate up swiftly from 0.10% to 1.35%. The market is pricing a cash rate at 3.2% by year-end but we believe that around 2.25% is more likely. The direct impact of rate rises in Australia, due to most borrowers being on variable-rate mortgages, demands an assessment period. With living costs rising so abruptly as well, the economy could stagnate if the consumer recesses quickly.

Relative Value by Sector