The investment landscape faces enormous uncertainty following the Russian invasion of Ukraine. The long slog to a post-Covid world has been meaningfully derailed. Energy and soft commodity prices are likely to remain high. The case for developed market (DM) government bond yields is less clear given current elevated inflation readings but the traditional desire for such a global safe haven is likely to be powerful. Our view remains that the global economic recovery from the Covid pandemic will be underpinned by responsible central bank policy that recognizes the detrimental effect that elevated energy prices and the uncertain situation in Eastern Europe will have on global growth. We have seen a rapid re-pricing of monetary policy expectations. While tensions in Ukraine are pushing up short-term energy prices and inflation, the medium- to long-term impacts have yet to be determined. Western Asset’s view is that while data on inflation and labor markets will likely lead to accelerated tightening schedules across a number of key DM central banks, the 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. 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

Global Market Rates: Relative Value by Region

CANADA: Provincial and corporate spreads have recovered from the Q1 shift in policy expectations. We expect spreads to narrow modestly further as economic data runs at or above trend despite the inflationary and geopolitical risks. Longer-term bond yields may still move higher, though we note that long-dated inflation expectations remain below the BoC targets.
US: We expect that yields will be guided by expectations for Fed policy at the front end of the curve, and long-term expectations for secular growth and inflation at the back end. As the Fed path becomes more established that should also bring down realized volatility for yields.
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 further widening of yields and spreads, especially if the ECB ends its asset purchases quickly in line with our expectations. The outlook for France depends on whether the outcomes of the presidential and parliamentary elections will be aligned.
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. The Bank of Japan (BoJ) will maintain the current monetary accommodation for a while until its 2% inflation target is met in a sustainable manner.
AUSTRALIA: We are focused on the 10-year and back end of the curve as we expect the RBA to remain balanced and that it won’t move at the speed and magnitude that the market has now factored in. Semi-governments are looking fully priced, whereas high-grade supranational debt is looking attractive.
See Relative Value by Sector section for the Emerging Markets outlook.
US With the further distortions/disruptions from the war in Ukraine muddying the inflation waters, the risk is that the Fed—or the markets—will overdo the increases in yields, slowing the US economy more than would otherwise occur.
Canada The Bank of Canada’s (BoC) rate-hiking cycle has begun and will likely move in line with the US Fed’s, though with CPI inflation running lower and the currency a bit stronger. While we remain concerned about the too-hot housing market, higher mortgage rates to date have had limited impact. With money market rates already pricing in 2.5% policy rates by end-2022, any slowing in the labor market or decline in reported inflation could lower market yields substantially. Meanwhile, we expect the BoC to match US policy rate hikes through Q3.
Europe The war in Ukraine is threatening the outlook for both inflation and growth. We expect more fiscal support to come through in due course, and a fast end to the ECB’s asset purchases. At this point, however, it is far from clear whether there will be rate hikes on the continent in 2022. 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.
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 2.0% to 2.5% in 2022 and 1.5% to 2.0% in 2023, but at a slower pace than before because of greater uncertainties and higher prices in energies and foods due to Russia’s war. Japan has significant reliance on imports of energies and foods. The BOJ just announced its commitment to loosen monetary policy by capping the 10-year JGB yield at 0.25%.
Australia The Reserve Bank of Australia (RBA) has remained relatively calm holding the cash rate at an emergency setting of 0.10%. With the 3%+ level for wages growth in sight with labour tightness abound, June now looks likely for lift-off, with a steady tightening approach likely to follow with a 1% cash level by year-end and 2% by end-2023.

Relative Value by Sector