Global Fixed Income Bulletin
Central Banks Talk Normalization

Global Fixed Income Bulletin

Central Banks Talk Normalization


July 2017

While the first half of 2017 was about reflation, a unique aspect of the second half stems from central bank policies to remove accommodation, which is creating unknown risk factors. The U.S. Federal Reserve (Fed) remains above the U.S. Treasury market in terms of rate expectations. The primary reason for the divergence is that inflation has been declining. The success of these planned policy moves will mainly depend on how global economic and financial conditions evolve. Our base case is that the normalization process will be orderly, supporting risky assets. The main risk will be a policy error in China. 

Developed Market (DM) Rate/Foreign Currency (FX): Yields in DM rose in June, led by Europe. Germany 10-yr yields rose 16 basis points (bps), while the periphery spreads to bunds tightened as a result of good data and more hawkish European Central Bank (ECB) comments. In the U.S., the Fed raised rates by 25 bps at its June meeting. 

We believe the ECB as well as the performance of bunds holds the key to performance across global treasury markets, with higher bunds leading the rest upward. In addition, higher U.S. Treasury yields will depend on higher U.S. inflation. If inflation improves, we believe that U.S. Treasury 10-year yields may end the year close to 2.60 percent. 

Emerging Market (EM) Rate/FX: EM fixed income asset returns were mixed in June with investment-grade assets outperforming high-yield, currencies weakening versus the U.S. dollar, and corporates outperforming sovereigns within dollar-denominated debt.

We believe that DM yields will continue to support the “right” carry opportunities. We think that (eventual) steeper DM yield curves warrant the shortening of duration exposures with a focus on attractive higher-yielding currencies/countries.

Credit: Investment-grade corporate spreads are now at the tightest level in nearly three years, returning to post-crisis lows of July 2014. In Europe, the restructuring of weak banks in Spain (Popular) and Italy (Veneto/Vicenza) were viewed as positive, as they bailed in subordinated bondholders while protecting senior bondholders. Financials outperformed other sectors.

We are slightly more constructive on the U.S. market compared to the European market, mostly due to relative valuation. Given current valuations, we do not expect a drastic move tighter in spreads; however, spreads may continue to grind tighter if the current backdrop persists.

Securitized: Agency mortgage-backed securities (MBS) had a mixed performance in June, positive relative to U.S. Treasuries but still negative on an absolute basis, while credit-related securitized assets saw continued gains from spread tightening and lower rates-oriented risk exposure.

The Fed is on pace to purchase over $300 billion agency MBS in 2017, and we believe that ending this reinvestment could have a significant negative impact on agency MBS. The increasing distress in the retail commercial mortgage-backed securities (CMBS) market represents both a significant risk and a significant opportunity. We believe that careful security selection can prove to be particularly beneficial in this market.

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.

All information provided is for informational purposes only and should not be deemed as a recommendation. The information herein does not contend to address the financial objectives, situation or specific needs of any individual investor.

The document is a general communications which is not impartial and has been prepared solely for information and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Any charts and graphs provided are for illustrative purposes only. Any performance quoted represents past performance. Past performance does not guarantee future results. All investments involve risks, including the possible loss of principal.

Prior to making any investment decision, investors should carefully review the strategy’s/product’s relevant offering document. For the complete content and important disclosures, refer to the link above.

CRC 1842397 Exp. 07/31/2018

It is important that users read the Terms of Use before proceeding as it explains certain legal and regulatory restrictions applicable to the dissemination of information pertaining to Morgan Stanley Investment Management's investment products.

The services described on this website may not be available in all jurisdictions or to all persons. For further details, please see our Terms of Use.

Not FDIC Insured—Offer No Bank Guarantee—May Lose Value
Not Insured By Any Federal Government Agency—Not A Deposit

Privacy & Cookies    •    Terms of Use

©  Morgan Stanley. All rights reserved.

Morgan Stanley Distribution, Inc. Member FINRA/SIPC.