William Riegel, Chief Investment Officer TIAA Investments
October 7, 2016
In Europe, U.K. Prime Minister Teresa May announced that she would invoke Article 50 of the Lisbon Treaty in March, setting the stage for the U.K. to leave the European Union (EU) two years from that date. (An extension beyond two years is possible but would require the unanimous consent of the EU’s 27 other members.) May also indicated that she would seek a clean break (or “hard” Brexit), with few concessions on trade and migration. At the same time, European leaders began to prepare for a tough round of Brexit negotiations. This uncertainty sent the British pound tumbling over 4% and weighed on Europe’s broad STOXX 600 Index, which fell 1.0% for the week (in local terms).
Despite positive inflows, returns for non-Treasury “spread sectors” were broadly negative for the week through October 6. High-yield bonds, however, bucked that trendwith the help of a 3.2% rally in crude oil prices, bringing their year-to-date gain to 15.6%.
Among the week’s other reports:
Despite the modest jobs growth, the U.S. economy is improving as we expected, with data on both manufacturing and service-sector business activity outstripping forecasts. In fact, this week’s releases have begun to reflect our position that the economy’s pause in August was mostly driven by seasonal weakness in data measurement rather than lackluster underlying demand.
In fixed-income markets, a rising-rate environment should allow investment-grade (IG) corporate bonds to outpace both their below-investment-grade counterparts and emerging-market debt, as credit spreads compress further in the IG space. Shorter-dated asset-backed securities and leveraged loans may also be poised to outperform. Bonds overall remain highly susceptible to continued communications from the ECB and the Fed, as both dovish and hawkish central bank guidance can have an outsized impact on market interest rates.
Meanwhile, the Fed has positioned itself to raise interest rates in December. Barring a major economic or financial market shock, we believe a rate hike of 25 basis points (0.25%) is in store. The U.S. economy remains on a 2% growth path, a trajectory we don’t expect to change in coming quarters.
Foreign stock market returns are stated in U.S. dollars unless noted otherwise.
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