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Invesco Fixed IncomeGlobal Markets in Transition
Rob Waldner, Chief Strategist, Invesco Fixed Income
September 2014
For use with SVIA National Fall Forum.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed herein are based on current market conditions and are subject to change without notice. Past performance does not guarantee future results.
Invesco Advisers, Inc. is an investment adviser and does not sell securities.
Structural factors such as demographic headwinds will limit potential GDP growth globally
With valuations stretched, active asset allocation and skilled security selection are key to generating returns
GDPPotential
Economies differ in cycle positioning, but current cycles are likely to be lower and longer globally
Major economies require diverging policy responses given different points in economic cycle
Real GDP Growth =
Available Labor
Labor Utilization
Productivity
Central Bank Policies
Point in Cycle
Active Positioning
The global economy is in a period of transition that affects growth, inflation and asset pricing
2
GDP growth tracks component factor growth
Primary components include labor force and productivity factors
We expect demographics to be a headwind for key components of global growth
Available Labor
Potential GDP =
Labor Utilization ProductivityX X
1 2 3
3
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
1982-1990 1991-2001 2001-2007 2009-2012 ForecastPotential
% C
on
trib
uti
on
to
Real
GD
P
Employment/Population Civilian Population
Labor Productivity Real GDP Growth
United States: GDP growth & component contribution
The growth accounting framework can be used to forecast long term GDP potential
Source: Federal Reserve Bank of St. Louis, US Bureau of Labor Statistics, Invesco calculations
4
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
20
05
20
10
20
15
20
20
20
25
20
30
United States
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
20
05
20
10
20
15
20
20
20
25
20
30
Japan
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
20
05
20
10
20
15
20
20
20
25
20
30
Euro Zone
0200,000400,000600,000800,000
1,000,0001,200,0001,400,0001,600,000
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
20
05
20
10
20
15
20
20
20
25
20
30
China
0-14 years 15-64 years 65+ yearsPopulation (000’s)
The aging of societies is global with 65+ age groups growing and working age cohort slowing or declining
Source: United Nations, Department of Economic and Social Affairs, Population Division (2013). World Population Prospects: The 2012 Revision, DVD Edition. Internal Use Only.
5
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
20
05
20
10
20
15
20
20
20
25
20
30
Japan Working Age Population (000’s)
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
China Working Age Population (000’s)
0
50,000
100,000
150,000
200,000
250,000
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
Euro Area Working Age Population (000’s)
0
50,000
100,000
150,000
200,000
250,000
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
US Working Age Population (000’s)
While varying across countries, trends foreshadow a declining pool of labor across many economies
Source: United Nations, Department of Economic and Social Affairs, Population Division (2013). World Population Prospects: The 2012 Revision, DVD Edition. As of September 2014.
Source: international Labour Organization, Key Indicators of the Labour Market database 2012
Labor participation rates are under pressure and trending down in many economies
6
50
52
54
56
58
60
62
64
66
68
United States
50
52
54
56
58
60
62
64
66
Japan
50.0
51.0
52.0
53.0
54.0
55.0
56.0
57.0
58.0
European Union
50
55
60
65
70
75
80
85
China
7
52
54
56
58
60
62
64
66
68
2/1
/1950
9/1
/1951
4/1
/1953
11/1
/1954
6/1
/1956
1/1
/1958
8/1
/1959
3/1
/1961
10/1
/1962
5/1
/1964
12/1
/1965
7/1
/1967
2/1
/1969
9/1
/1970
4/1
/1972
11/1
/1973
6/1
/1975
1/1
/1977
8/1
/1978
3/1
/1980
10/1
/1981
5/1
/1983
12/1
/1984
7/1
/1986
2/1
/1988
9/1
/1989
4/1
/1991
11/1
/1992
6/1
/1994
1/1
/1996
8/1
/1997
3/1
/1999
10/1
/2000
5/1
/2002
12/1
/2003
7/1
/2005
2/1
/2007
9/1
/2008
4/1
/2010
11/1
/2011
6/1
/2013
The US Labor Force Participation Rate (LFPR), 1950-2014, reflects secular trends in culture and demography
US Labor Force Participation Rate
US Labor Force Participation Rate, SA
Rise of dual income family & baby boomer generation enters prime working age
Oldest baby boomers enter retirement age
Source: US Bureau of Labor Statistics, Bloomberg, chart by Invesco as of September 2014.
8
-0.06
-0.03
0.00
0.03
0.06
0.09
0.12
0.15
1995 2000 2005 2015 2020 2025 2035 2040 2045Yearly %
Change in G
row
th
-0.08
-0.04
0.00
0.04
0.08
0.12
1995 2000 2005 2015 2020 2025 2035 2040 2045Yearl
y %
Change in G
row
th
UK Germany Italy France Spain
-0.08
-0.06
-0.04
-0.02
0.00
0.02
0.04
0.06
1995 2000 2005 2015 2020 2025 2035 2040 2045
Yearly %
Change in G
row
th
0.00
0.02
0.04
0.06
0.08
1995 2000 2005 2015 2020 2025 2035 2040 2045
Yearl
y %
Change in G
row
th
US Japan
Europe China
Demographic dividends to productivity growth are falling, impacting both DM and EM economies
Source: HSBC as of June, 2014
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Multifactor Productivity Contribution of Labor Composition
Contribution of Capital Intensity Labor Productivity
InterstateSystem
Tech Boom
Discovery and adoption of innovation lead periods of high productivity growth
Productivity follows investment, but with a lag
Productivity (5-year growth rate, annualized)
Source: US Bureau of Labor Statistics, 2013
Catalysts for increased productivity growth are not evident
9
-35%
-25%
-15%
-5%
5%
15%
25%
35%
45%
55%
Jan-0
0
Dec-1
3
Jun-1
3
Dec-1
2
Jun-1
2
Dec-1
1
Jun-1
1
Dec-1
0
Jun-1
0
Dec-0
9
Jun-0
9
Dec-0
8
Jun-0
8
Dec-0
7
Jun-0
7
Dec-0
6
Jun-0
6
Dec-0
5
Jun-0
5
Dec-0
4
Jun-0
4
Nikkei Hang Seng
-28%
-21%
-14%
-7%
0%
7%
14%
21%
28%
35%
Jan-0
0
Dec-1
3
Jun-1
3
Dec-1
2
Jun-1
2
Dec-1
1
Jun-1
1
Dec-1
0
Jun-1
0
Dec-0
9
Jun-0
9
Dec-0
8
Jun-0
8
Dec-0
7
Jun-0
7
Dec-0
6
Jun-0
6
Dec-0
5
Jun-0
5
Dec-0
4
Jun-0
4
S&P 500 Stoxx 600
Capex Growth (YoY%) – U.S. and Europe Capex Growth (YoY%) – Asia
10
Contribution of capex and innovation to productivityCapex trends are weak and mind the lag even if it accelerates
Source: Macrobond, as June 30, 2014.
IFI believes the US labor market is tightening, causing broad implications for policy and growth potential
11
1 Market consensus and the Fed’s forecast are that the non-accelerating inflation rate of unemployment (NAIRU) will not be reached until 2015
2 Many view a declining labor force participation rate (LFPR) as a cyclical phenomenon and indication of slack in the US labor market
3 IFI reframes the labor market discussion and concludes the US labor market is tightening and that NAIRU could be reached as early as Q4 2014
4 Reaching full employment has broad implications for wage pressures, inflation, and Fed forward guidance about short term interest rates
5 IFI also concludes that the LFPR will continue to decline due to demographic factors and may reduce US trend growth for at least the next decade
Historically, the employment / population ratio and the unemployment rate have moved in opposite directions
55
56
57
58
59
60
61
62
63
64
65
0
2
4
6
8
10
12
1/1
/1950
9/1
/1952
5/1
/1955
1/1
/1958
9/1
/1960
5/1
/1963
1/1
/1966
9/1
/1968
5/1
/1971
1/1
/1974
9/1
/1976
5/1
/1979
1/1
/1982
9/1
/1984
5/1
/1987
1/1
/1990
9/1
/1992
5/1
/1995
1/1
/1998
9/1
/2000
5/1
/2003
1/1
/2006
9/1
/2008
5/1
/2011
1/1
/2014
US Unemployment Rate, SA
US Employment Population Ratio Total in Labor Force, SA
Source: US Bureau of Labor Statistics, Bloomberg, chart by Invesco as of June 2014.
Recently this relationship has ceased, with a dramatic decline in the unemployment rate occurring, while the employment /population ratio remains nearly flat
Employment /population ratio and unemployment rate, 1950-present
12
Most of the workers who left the labor force from the fourth quarter of 2007 through 2013 did so for what IFI believes are persistent reasons
US Labor Force Participation Rate, 1950-2014
Source: Shigeru Fujita, Philadelphia Federal Reserve (Feb, 2014) / Invesco.
Transitory vs. Persistent Changes in Labor Participation Rate 4Q07 – 4Q13
13
There is evidence that the labor market is behaving in a normal cyclical pattern
14
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
-2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00
Avera
ge H
ourly E
arn
ings o
f Pro
duction E
mplo
yees,
YoY
(%)
Unemployment Gap (%), CBO measurement
1986-2006
2007-2012
2013
Linear (1986-2006)
Labor Market Cycles – Quarterly Earnings versus Unemployment Gap
Source: Daly, Hobijn, Ni, FRB San Francisco, July 2013. FRB St. Louis, Federal Reserve Economic Data (FRED), Congressional Budget Office (CBO), Bureau of Labor Statistics (BLS), chart by Invesco as of June 2014.
Linear equation (1986-2006):
Y = -0.7043x + 3.2877R2 = 0.5766
IFI’s modeling and analysis indicate major economies are at different points in their economic cycles
15
Peak
Trough Trough
Peak
Trough
Length of economic cyclefollowing banking crisis in
advanced economies is substantially longer
Average length of each U.S. economic cycle since 1960 is
6.4 years
Previous potential GDP
Future potential GDP
Cycles lasts 2–2.5x longer following financial crises
Points in current cycle 1.5x longer than average recession
Structural factors will pressure trend growth over next decade
Demographics, productivity and deleveraging are key factors affecting the global economy
Cycles often elongated after a banking crisis Structural factors shift GDP downward
Given structural demographic headwinds and ongoing deleveraging, cycles are now likely to be longer and shallower
16
Source: Reinhart, Reinhart and Rogoff 2012
17
Majority of spread compression during tightening cycles occur in the first one-third of cycle
Performance during widening cycles is generally more distributed
Price activity closely centered around late/early cycle turns in the market
Widening Cycles Stages
70%
92%86%
17%
6%
-1%
14%
2%
15%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1991–1997 2002–2007 2008–Current
1st 2nd 3rd
29%
12%
36%
19%
35%
69%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997–2002 2007–2008
1st 2nd 3rd
Tightening Cycle StagesPercentage of Total Spread Change by Stage
Widening Cycles StagesPercentage of Total Spread Change by Stage
Performance of credit spreads illustrate the importance of identifying market transition
Source: Barclays, Bloomberg as of March, 2014.
Ending QE
BOJ policies continue to target increased inflation as Japan embarks on structural change
ECB Easing
Monetary policy will adjust as necessary to growth developments as China implements structural reforms
Current cycle positioning requires diverging central bank policies
Fed is ending QE, reduced slack in labor market means tightening may be brought forward
ECB is easing to stem deflation risk, continued easing will be necessary
BOJ policies China Reform
18
0
1
2
3
4
2014 2015 2016 2017 2018
(%)
Blue Chip, consensus Blue Chip, median
Primary dealers, 25th percentile Primary dealers, median
Primary dealers, 75th percentile June 2014 SEP, 25th percentile
June 2014 SEP, median June 2014 SEP, 75th percentile
Federal Funds (FF) Rate Market Surveys and FOMC Summary of Economic Projections (SEP) FF Views
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
2 3 5 7 10 15 20 30
9/10/2014 SEP 25th
SEP Median SEP 75th
19
Current Treasury Yield Curve and Estimates Derived from FOMC SEP June 2014 Views
Source: Surveys: Federal Reserve Bank of San Francisco, September 8, 2014. Blue Chip Financial Forecast ,August 2014; Federal Reserve Bank of New York Primary Dealer Survey, July 21, 2014; Board of Governors of the Federal Reserve System “Summary of Economic Projections”, June 2014.
Source: Federal Reserve Summary of Economic Projections (June 2014), Invesco analysis. Derived from rates paths implied from 25th, median and 75th percentiles of the Federal Reserve SEP June 2014
Yie
ld L
evel (%
)
Market surveys currently forecast the path of Federal Funds Rate to the dovish side of FOMC views
IFI key themes and positioning have reflected diverging global fundamentals and policies
20
Growth improving with labor slack diminishing in the US. Potential to bring the first Fed rate increase forward
ECB to ease to avoid deflation and support Eurozone growth
Fundamentals for credit markets supportive although valuations are tight
Views
Treasury curve flattening: underweight short end of US Treasury curve
US dollar strength: favor US$ especially against Euro, Yen, and many EM currencies
Peripheral European bonds tighten relative to core as fundamentals improve, European bank spreads tighten
Reduce risk in credit markets. Position sectors tactically, focus on alpha from security selection
Positioning
Our credit, rates and FX views
21
View Credit Rates Currency
Bank LoansIG MuniHY Muni
EM Corporates
Mexico
IndiaMexico
Indonesia
India
New Zealand
Indonesia
Brazil
CMBSGlobal IGHigh YieldEM Hard
ABSNon Agency RMBS
US IG
GermanyCanadaJapanItalyChina
Australia South Korea
RussiaTurkey
UK
Brazil
China
Columbia
Russia
South Korea
New Zealand
Canada
EM Local South Africa
US
Japan
Australia
U.K.
Singapore
Swiss
South Africa
Thailand
Europe
B
C
D
Bullish
A
B
C
D
E
Bearish
Source: Invesco, as of September, 2014. For illustrative purposes only. Forecast may change without notice.
Structural factors such as demographic headwinds will limit potential GDP growth globally
With valuations stretched, active asset allocation and skilled security selection are key to generating returns
GDPPotential
Economies differ in cycle positioning, but current cycles are likely to be lower and longer globally
Major economies require diverging policy responses given different points in economic cycle
Real GDP Growth =
Available Labor
Labor Utilization
Productivity
Central Bank Policies
Point in Cycle
Active Positioning
The global economy is in a period of transition that affects growth, inflation and asset pricing
22
Invesco Fixed IncomeGlobal Markets in Transition
Rob Waldner, Chief Strategist, Invesco Fixed Income
September 2014
For use with SVIA National Fall Forum.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed herein are based on current market conditions and are subject to change without notice. Past performance does not guarantee future results.
Invesco Advisers, Inc. is an investment adviser and does not sell securities.