Most global fixed-income sectors generated negative total returns during the first quarter. Sovereign yields generally moved higher along with rising global inflation expectations, and easing political uncertainty in Europe and the anticipated inflationary impact of US trade tariffs contributed to the increase in the bond yields of many government issuers. Credit spreads widened amid a pickup in equity-market volatility, higher currency hedging costs, and weaker demand for credit, as US firms repatriated overseas funds held in high-quality corporate debt. The Trump administration’s protectionist trade rhetoric placed pressure on the US dollar, which weakened against most major currencies.
In the US, fourth-quarter GDP grew at a 2.9% annualized rate, labor market data surprised to the upside, and manufacturing surged, although higher rates weighed on some housing-market indicators. Eurozone GDP grew at a 2.7% annualized rate in the fourth quarter, matching its strongest level since 2011. Eurozone manufacturing and services Purchasing Manager’s Indices (PMIs) each slowed but remained well in expansionary territory. United Kingdom GDP grew at just 1.4% year-over-year during the fourth quarter, making the UK the only G7 nation whose pace of growth slowed from 2016. Japan’s jobless rate fell to the lowest level in 25 years, helping to lift inflation; however, manufacturing weakened on higher input costs. China’s manufacturing and non-manufacturing PMIs declined, partially disrupted by new regulatory initiatives aimed to curb debt growth and control pollution.
Global monetary policy generally continued along a less accommodative path during the period. The Bank of Japan (BOJ) was an outlier, pushing back against speculation that it would begin to unwind its stimulus and pledged “unlimited” purchases of government bonds to maintain its zero-interest-rate policy. Nevertheless, the US Federal Reserve (Fed) hiked rates by an additional 25 basis points in March and projected two more hikes this year. Dissenting votes at the Bank of England’s (BOE) meeting suggested a higher likelihood of a rate hike in May, while the European Central Bank (ECB) adjusted its forward guidance to remove its official easing bias and is expected to cease asset purchases by September.
Amid these shifts to more normalized policy, sovereign yield curves continued to flatten to varying degrees across most developed markets. Short-term yields in the US and UK increased sharply on expectations for more aggressive tightening, while longer-term yields declined in most major developed markets where inflation remained tame. In the US, firmer inflation data and expectations for continued tightening pushed Treasury yields higher across the curve during the first half of the quarter, but concerns about a global trade war and potentially adverse regulation in the technology sector caused yields to decline later in the quarter. Yields on UK gilt and German bunds increased on the BOE’s hawkish outlook and the ECB’s signaling of a gradual end to quantitative easing; while progress on Brexit negotiations, the formation of a coalition government in Germany, and decreasing risks of a purely anti-establishment government in Italy all helped to support growth expectations.