As in 2018, global economic growth is likely to continue returning to normal this year. On average, global PMIs are returning to their range of the last six years – between 50 and 53 – the only exception having been 2017 with 55. Global GDP growth is expected to be 3.4% this year, also close to the average seen in recent years*. At this stage we rule out a recession for 2019. We are more likely to see a soft landing typical of a regime in which growth is stabilising.

2019: a record number of volatility spikes?

The current return to normal at the economic level has been accompanied, in the last few weeks, by central banks adopting a new line and embarking on a genuine shift in monetary policy. The Fed and the ECB have executed a rapid, synchronised change of direction, adopting a much more accommodative stance and distancing themselves from their previous monetary tightening.

Furthermore, the Fed has made its monetary policy contingent on inflation, effectively putting hikes on hold for now as US core inflation is still a long way from consistently hitting its 2% target. According to projections, and without an underlying acceleration, core inflation could fall back to 1.6% by the end of this year**.

The macroeconomic outlook is broadly positive, but this is unlikely to spare financial markets from increasingly frequent volatility spikes. In the last few quarters, bouts of market stress have become exceptionally frequent and severe, similar to the shocks seen in 2008. These volatility spikes are the result of geopolitical and political uncertainties, including the China–US trade conflict, political turmoil in Italy and the ongoing Brexit saga. They are also being caused by a growing shortage of liquidity, which plays a key technical and structural role in market movements.

For example, the depth of the US equity market (S&P 500 index) hit historically low levels in 2018, and thin liquidity exacerbated the correction seen in December 2018. As things stand, we could see a record number of volatility spikes in 2019.

Gain exposure to credit through CDS indices, which exhibit higher liquidity

In view of the economic environment, the end of central-bank monetary tightening and the upturn in volatility, bond management could benefit from three main approaches: taking on more credit risk, increasing duration, and making use of liquid debt instruments. The sudden shift in central-bank policy and attractive valuation levels following the December correction have favoured gradually increasing credit exposure. At the same time, with monetary tightening coming to an end, it is becoming attractive to increase interest rate exposure again and therefore build more balanced portfolios. US 5-year sovereign bond yields were close to 2.5% at the end of February, higher than their average over the last five years.

Finally, liquidity remains all-important. To achieve it, we advise using CDS indices, which once again proved their robust liquidity in December, and outperformed corresponding traditional bonds. Against a background of greater volatility, investors should focus on liquid credit instruments, which perform better during times of crisis.

Christel Rendu de Lint
Head of Fixed Income