Global fixed-income sectors generated mixed results during the second quarter. Sovereign yields outside of Europe generally moved higher, driven by continued global growth momentum and rising inflation expectations. Government bonds enjoyed short-lived periods of strength, however, amid escalating tensions between the U.S. and its trade partners and bouts of elevated political uncertainty in Europe. Concerns over increased leverage and heavy supply of corporate debt due to a pickup in mergers and acquisitions activity weighed on credit spreads. The U.S. dollar rallied versus most currencies, as strong U.S. economic data reinforced expectations that policy rates are likely to continue to move higher.
Global monetary policies diverged during the period. The U.S. Federal Reserve (Fed) raised its target rate by 25 basis points, as expected, and forecast two additional hikes this year—one more than was projected at the March Federal Open Market Committee meeting. The Committee upgraded growth and employment projections, while also shifting inflation expectations higher. The European Central Bank (ECB) announced an end to quantitative easing, slated for December 2018, but pledged to keep policy rates unchanged at least through the summer of 2019. The People’s Bank of China (PBOC) unexpectedly cut its reserve-requirement ratio for most banks by 100 bps to free up lending to small businesses. The Bank of England (BOE) maintained its policy rate and asset-purchase program after growth fell shy of its forecasts.
In the U.S., first-quarter GDP grew at a 2.0% annualized rate, labor market strength continued, and small-business and consumer surveys painted an optimistic outlook for the economy. Supply shortages and higher mortgage rates led to mixed housing-market data. Eurozone economic confidence held firm despite announced trade tariffs between the currency bloc and the U.S. Eurozone inflation rose to 2% year-over-year as a result of higher energy prices, while the core rate fell to a 1% year-over-year pace. Japanese retail sales indicated weakness in consumer spending despite the jobless rate falling to the lowest level in 25 years. China’s manufacturing Purchasing Managers’ Index (PMI) declined due to weaker exports, while new order helped lift its non-manufacturing PMI.
Sovereign yield movements were somewhat limited across most developed markets, as increasing inflation pressures balanced heightened political uncertainty. Expectations for continued monetary tightening lifted U.S. and Canadian short-term yields. Ten-year yields in the countries fell sharply along with broader risk aversion following the Italian election outcome, but finished higher over the quarter as inflation expectations rose. Elevated political uncertainty in Europe—including the formation of a populist Italian government and the ousting of Spanish Prime Minister Rajoy—provided support for core European government yields at the expense of peripheral yields. Emerging-markets debt and investment-grade corporate bonds posted negative excess returns as credit spreads widened. High-yield bonds generated positive excess returns, as coupon income offset widening spreads, while the sector also benefitted from continued demand—and a lack of supply—for income.
