Below is an excerpt from the Fixed Income Insights: 2016 Outlook
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As we approach the end of the year, we reviewed several of our theses from the TCH 2015 Outlook:
- On balance, we believe the U.S. economy will realize moderate growth in 2015
- There is broad consensus across investors, economists and monetary policymakers that the Fed funds rate will increase around mid-2015… Our expectations for the Fed funds rate are toward the lower and later end of market expectations. Further, we foresee the Fed maintaining its $4.5 trillion balance sheet and anticipate it continuing to reinvest principal payments
- Weak commodity prices—specifically within the energy sector—may further entrench current inflation expectations
- Perhaps the more significant risk remains China
Our projections were largely realized, though the last projection overwhelmed the first three. The U.S. economy did in fact manage moderate-but-unexciting growth in 2015. Inflation did remain low, in large part due to lower energy costs. In response to the uninspiring, but positive, growth the Fed did maintain its enlarged balance sheet and forestall a rate hike for the first 350 days of 2015. Anticipating market conditions of moderate growth, limited inflation and accommodative monetary policy, a constructive view on U.S. credit and maintaining portfolio duration were attractive positioning.
While those views were realized, it was in fact the Chinese economy that had the biggest impact on financial markets. A significant decline in the Chinese equity markets beginning in June led to global concern regarding a slow-down in Chinese growth. Declining Purchasing Managers’ Index (PMI) and Gross Domestic Product (GDP) numbers led to global growth concerns, the first U.S. equity market correction in four years and a broad-based increase in market volatility. In response to the slowdown, the People’s Bank of China (PBoC) has conducted six interest rate cuts during the last year and a half.
Commodity prices declined rapidly as global growth expectations were recalibrated lower. Exacerbating the situation for commodities, such as oil, were continued strong supply market dynamics. In this environment, credit spreads, particularly those for industries carrying the greatest sensitivity to these variables, widened significantly. Further, as the U.S. corporate bond market saw robust issuance throughout 2015, the record issuance contributed to an increased cost of funding and resulted in tighter overall financial conditions, despite the U.S. Federal Reserve remaining on hold longer than most expected.
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