Investment Insight
Understanding the “Known Unknowns”

Investment Insight

Understanding the “Known Unknowns”


February 2017


  • Despite uncertainties surrounding the timing and exact specification of the Trump administration’s policies, we see the possibility of real reforms and actions (e.g., tax and spending) that could sustain positive economic momentum in the U.S. With unemployment low and wages rising, albeit gradually, inflation should continue to move higher. This will allow the Fed to continue to raise interest rates. However, the pace is not likely to increase unless one of two conditions is met: (1) inflation accelerates; and (2) fiscal policy becomes much more expansionary. In the interim, the probability of recession has fallen with the price of more economic variability down the road: The old-fashioned business cycle may be coming back!
  • For the first time since 2013, we are witnessing several bond bearish forces arriving simultaneously: improving economic data/rising inflation, both in the U.S. and the rest of the world, less easy monetary policy, easier fiscal policy and rising risk premiums. Basically, a reversal of all the factors that powered yields lower over the last several years. We remain modestly underweight overall duration to help protect portfolios from further improvements in growth and inflation.
  • We still expect the EM/DM growth differential to recover during 2017 in favor of EM as the negative growth impacts from Brazil and Russia lessen. On Mexico, post the U.S. elections, we note that the Mexican peso is now the most undervalued currency in EM and is pricing in a fairly severe slowdown in Mexican growth and worsening in the funding of the current account deficit. The currency could outperform if these risks lessen. We believe that EM assets could well absorb Fed rate hikes in 2017 if driven by increasing U.S. growth and not inflation; however, assets remain vulnerable to spikes in U.S. policy uncertainty.
  • We anticipate that the U.S. credit market will continue to benefit from rising equity prices, supportive data, positive earnings, rising interest rates and growth optimism in the coming month. Technical factors, in terms of issuance are also likely to be supportive of spreads.
The Global Fixed Income team follows a seamless process with a global outlook. They seek to identify and capture the potential value in situations where the market's implied forecasts are extreme.

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

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1703997 Exp. 2/07/2018

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