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Economic Insights

Our experts offer their insights on the implications of the trade-fueled market tumult.

A renewed escalation in U.S.-China trade tensions, along with Beijing’s decision to devalue the yuan, sparked a fresh episode of market volatility on Monday, August 5. Global equity indexes slumped, while investors flocked to haven investments such as government bonds; in the United States, the three-month/10-year U.S. Treasury curve reached its deepest inversion since the lead-up to the 2008 financial crisis, according to Bloomberg. Based on fed funds futures data from Bloomberg, investors expect a 100% chance of a rate cut by the U.S. Federal Reserve (Fed) in September, with a strong likelihood of similar moves over the next 12 months.

What should investors be thinking about right now? We asked three Lord Abbett investment experts to assess the implications of the current volatility for select asset classes:

Timothy Paulson
Investment Strategist, Taxable Fixed Income

It is our view that the market response to flare-ups in tariff tensions with China is more about sentiment than actual changes in economic fundamentals. The ultimate impact on U.S. gross domestic product (GDP) is likely to be fairly small and more than offset by the Fed’s accommodative tendencies, along with still-easy financial conditions in the United States.  The United States, with a large trade deficit, is not overly sensitive to trade the way that some export-driven economies, such as Germany and Japan, have been.

We have paid close attention to the growing short-term disconnects between investor sentiment and economic fundamentals, and the way that markets respond. In short, we find that sentiment has had an outsized impact on shorter-term market moves, but that as the initial sentiment fades, fundamentals reassert themselves as the dominant drivers of valuations. Thus, we believe sentiment-driven swings represent compelling investment opportunities. We would point to recent examples such as the fourth quarter 2018-first quarter 2019 selloff and subsequent reversal, and a similar, smaller-scale situation in May and June of this year.

The U.S. economy remains in robust health, in our view, with very strong labor markets. This most recent market overreaction, while entirely predictable given the news cycle, is yet another reminder of why investors should not make decisions solely based on prevailing sentiment, but retain a long-term outlook tied to fundamentals, and view these swings as either noise—or compelling investment opportunities. 

Leah Traub
Partner & Portfolio Manager, Currency Strategies

The return of volatility to the equity and foreign exchange markets means that we are seeing weakness in emerging market asset classes and U.S. dollar strength against most currencies. Certain currencies, such as the Japanese yen and the Swiss franc, are considered “safe havens” to which investors turn when they want to reduce risk.

The euro, which has historically had a positive correlation to equities and would have weakened as volatility rose, has instead appreciated against the dollar in the past few days.  In our view, this is due to the very low interest rates in the Eurozone, which have caused investors to sell euro-denominated assets and the euro itself and buy other developed-market and especially emerging-market (EM) currencies and securities that carry higher interest rates. These types of “carry trades” typically get unwound when volatility spikes higher.  

Meanwhile, global, developed-market government bond yields have moved sharply lower, led by U.S. Treasuries, as expectations for further central bank easing increase.  Given this backdrop, investors may wish to become more selective in their allocations to EM securities, favoring certain countries and sectors less exposed to the trade tensions over a broad index, and reconsider pure carry trades that should underperform in higher volatility environments.  

Dan Solender
Partner, Director of Municipal Bonds

Municipal bonds have not seen the same volatility as other markets.  While muni yield rates are falling, similar to the move in U.S. Treasuries, the pace of decline has been slower, making ratios of municipal yields to Treasuries rise.  Muni-bond mutual fund flows continue to be very positive, based on Lipper data, with trading volumes on the lighter side.  While new issue supply is higher than normal this week, it is primarily due to a few outsized deals and overall the amount of new issues coming to the market continues to be on the lower side. 

The tax-free market is adjusting to 30-year high-grade bond yields being well below 3.00%, but the muni yield curve remains steeper than the Treasury curve, based on data from Thomson Reuters MMD, providing incremental yields for extending maturities.  Overall, the municipal bond market has been rallying at a slower pace than Treasuries, but there hasn’t been much change in trading volume, and overall credit quality remains strong.

 

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