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Market Commentary

Ken Leech
Chief Investment Officer


A smooth sea never made a skilled sailor. ~Franklin D. Roosevelt

Executive Summary

  • Optimism for a synchronized global recovery earlier this year has given way to anxiety over potential EM or European crises.
  • The divergence between economic data expectations for the US compared with other developed markets has been breathtaking.
  • With EM real yields relative to DM real yields at close to a 10-year high, the most important variable for EM returns remains improving global growth.
  • EM difficulties have suddenly become acute due to downwardly revised growth expectations, higher US rate expectations, a strongly rising US dollar, protectionism and sharply higher oil prices.
  • We expect solid growth in the US, China, Japan, Australia and non-emerging markets and do not share the extreme market pessimism about Europe.
  • While our viewpoint remains optimistic, maintaining portfolio assets to protect against the vagaries of downside risks is crucial.

The uneven nature of the global recovery has reared its ugly head again. The optimism for a global synchronized recovery at the beginning of the year has given way to anxiety over potential emerging markets (EM) or European crises. The divergence in performance between the US bond market and markets in the rest of the developed world has been breathtaking. The driver of this divergence is the expectation that US growth will pick up sharply in the second half of 2018, while growth expectations for Europe, China and EM have all been lowered.

Exhibit 1
Citi Economic Surprise Index
Source: Bloomberg. As of 25 May 18

The uneven nature of the global recovery has reared its ugly head again. The optimism for a global synchronized recovery at the beginning of the year has given way to anxiety over potential emerging markets (EM) or European crises. The divergence in performance between the US bond market and markets in the rest of the developed world has been breathtaking. The driver of this divergence is the expectation that US growth will pick up sharply in the second half of 2018, while growth expectations for Europe, China and EM have all been lowered.

“It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

The uneven nature of the global recovery has reared its ugly head again. The optimism for a global synchronized recovery at the beginning of the year has given way to anxiety over potential emerging markets (EM) or European crises. The divergence in performance between the US bond market and markets in the rest of the developed world has been breathtaking. The driver of this divergence is the expectation that US growth will pick up sharply in the second half of 2018, while growth expectations for Europe, China and EM have all been lowered.

“… some participants noted it might soon be appropriate to revise the forward-guidance language in the statement indicating that the ‘federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run’ or to modify the language stating that ‘the stance of monetary policy remains accommodative.’”

The uneven nature of the global recovery has reared its ugly head again. The optimism for a global synchronized recovery at the beginning of the year has given way to anxiety over potential emerging markets (EM) or European crises. The divergence in performance between the US bond market and markets in the rest of the developed world has been breathtaking. The driver of this divergence is the expectation that US growth will pick up sharply in the second half of 2018, while growth expectations for Europe, China and EM have all been lowered.

Exhibit 2
EM Local Market Returns Modeled Using EM-DM Growth Differentials, EUR/USD and Commodities
Source: Bloomberg, J.P. Morgan, Western Asset. As of 25 May 18
1Model uses the GDP differential, S&P GSCI Commodity Index and EUR/USD. Dotted line shows forecasts using Western Asset estimates.

The uneven nature of the global recovery has reared its ugly head again. The optimism for a global synchronized recovery at the beginning of the year has given way to anxiety over potential emerging markets (EM) or European crises. The divergence in performance between the US bond market and markets in the rest of the developed world has been breathtaking. The driver of this divergence is the expectation that US growth will pick up sharply in the second half of 2018, while growth expectations for Europe, China and EM have all been lowered.

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