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Global Macroeconomic Outlook

Q1 2023

Global Fixed Income team’s view as of 12/2/2022.

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Global Economy: Recession Risk Is Rising

Higher Borrowing Costs to Weigh on U.S. Growth

After entering a technical recession in the first half of 2022, the U.S. economy rebounded in the third quarter. But much of the gain was due to a narrowing trade deficit, driven largely by oil and natural gas exports. Business activity is downshifting and housing activity continues to weaken — trends likely to continue amid elevated inflation and sharply higher interest rates. We expect these factors, along with lower corporate earnings, to eventually pressure the job market, which so far has been surprisingly strong. A continuing housing market slowdown, a weakening labor market and mounting consumer and corporate challenges likely will push the U.S. economy into recession in the coming months.

Energy Crisis Stifles European Economy

In our view, recession risk is greater in Europe, largely due to its heavy reliance on gas imports from Russia. Surging energy prices, record-high inflation and rising interest rates are weighing on spending and production. Eurozone manufacturing has been contracting since July, and consumer confidence remains bleak amid the soaring cost of living. Similar challenges threaten the U.K. economy, which contracted slightly in the third quarter amid decades-high inflation and rising interest rates. With manufacturing declining and consumer and business confidence sinking, the Bank of England (BofE) has warned that the nation could face its longest recession since the 1940s.

COVID Policy Threatens Chinese Economy

China’s economy returned to expansion mode in the third quarter, thanks largely to government stimulus measures. Yet, China continues to face several domestic and global challenges. The nation’s zero-COVID-19 policy remains a major threat, as lockdowns restrain manufacturing and consumer confidence. Moderating exports, declining retail sales, a lingering property crisis and tighter global financial conditions also remain headwinds. While other emerging markets (EM) face mixed economic outlooks, we still expect commodity exporters to fare better than commodity importers.

Inflation: Prices Remain Elevated

U.S. Inflation Likely Has Peaked

Broad measures of headline and core inflation appear to have peaked, but we don’t expect swift or significant relief from high prices. Inflation likely will remain elevated and notably higher than its pre-pandemic levels. While core goods prices have been declining, core services costs, especially housing and labor, stay on the upswing and will keep inflation well above the Federal Reserve’s (Fed’s) target. Rising interest rates and a slowing economy will continue to slow down demand and cool cyclical inflation. But secular trends, including deglobalization and labor force shortages, likely will keep structural inflationary forces intact through 2023.

Europe Battles Record-High Inflation

Amid soaring energy prices and euro weakness, European inflation has soared to a record high. The war in Ukraine and its effects on the region’s energy supplies and food prices suggest that consumer prices will remain high in the near term. The European Central Bank (ECB) embarked on an inflation-fighting rate-hike plan in July, but prices continue to rise. In the U.K., inflation recently topped 11%, a 41-year high, even as the government unveiled its Energy Price Guarantee to constrain consumer energy costs. A series of BofE rate hikes also have not slowed the inflation rate, which will likely continue rising into early 2023.

China’s Inflation Remains Below Target

Inflation in China remains below its central bank’s target of 3%, largely due to a slowdown in food prices. China’s inflation rate remains sharply lower than developed and most other emerging markets. For example, Turkey and Argentina continue to face massive inflation rates. Energy prices, monetary policy and currency devaluations have led to unusually high inflation in parts of the developing world.

Monetary Policy: Central Banks Are Still Tightening

Fed’s Inflation Fight Risks Overtightening

While inflation has moderated, the Fed remains steadfast, waiting for concrete evidence that its tightening plan is defeating inflation. Meanwhile, the economy seems headed for recession. Its depth is highly uncertain, largely due to the long and variable lag associated with Fed action. Persistently high inflation isn’t affording policymakers the time to gauge the true economic impact of the rate hikes already enacted. Monthly inflation gains are fueling policymakers’ consistent tightening bias. Overtightening is now a key risk, but we believe the Fed is more comfortable with the risks of overtightening than the risks of undertightening.

ECB, BofE Rate Hikes Are No Match for Inflation

Despite a series of swift ECB rate hikes that lifted borrowing costs to the highest level since 2009, European inflation continues to soar. Policymakers expect to raise rates further to combat inflation, but a looming recession may lead to smaller rate hikes. In the U.K., a year-long rate-hike campaign has yet to stifle inflation. With little evidence that the nation’s slowing economy is taming inflation, additional rate hikes are likely. Forecasts suggest the key BofE lending rate will peak at 4.5% in the second quarter of 2023.

China Keeps Rates Steady

Despite a challenging economic backdrop, the People’s Bank of China remains wary of cutting rates and stoking further weakness in the yuan. Fostering additional declines in its currency raises the risk of large-scale capital outflows from investors seeking higher yields elsewhere, particularly in U.S. bonds. Maintaining stable policy rates should prevent U.S.-China interest rate differentials from widening too far while helping to stabilize the yuan. Elsewhere, many EM central banks have been aggressive in hiking rates to combat inflation and have reached or nearing the end of their tightening campaigns.

Interest Rates: Short-Maturity Yields Are Still Climbing

Treasury Yields Rise on Hawkish Fed Policy

Despite slowing economic growth and ongoing geopolitical tensions, we believe the Fed remains the primary driver of Treasury yield movements. As the central bank continues to tighten financial conditions, we expect short-maturity Treasury yields to continue to rise. But with recession risk escalating, we think rates in the intermediate portion of the yield curve are nearing a peak. We expect the 10-year Treasury note to settle near 3.5% in the coming months. Higher short-maturity rates and lower longer-maturity rates will foster additional
yield curve inversion.

European Yields Track Policy Rates

Soaring inflation and aggressive central bank tightening continue to drive European and U.K. government bond yields higher, even as recession appears imminent. In Europe, yields in peripheral countries, such as Italy and Spain, remain notably higher than in core countries, including Germany and France. In the U.K., where the central bank has been raising rates since December 2021, government bond yields are rising faster than their eurozone counterparts. We expect rates to peak in early 2023 as recession takes hold and central banks are forced to conclude their rate-hike campaigns.

Rates Remain Higher in Emerging Markets

In general, government bond yields in EM countries are higher than yields in most developed markets. Facing high inflation and potential currency devaluations, many EM central banks started raising rates before their peers in developed markets.

"We believe this dynamic should offer some support to select EM currencies and the potential for yield pickup from local rates."

Q1 2023 Investment Outlook Resources

Agency mortgages

A form of securitized debt that represents ownership in pools of mortgage loans and their payments.

Asset-backed securities (ABS)

A form of securitized debt (defined below), ABS are structured like mortgage-backed securities (MBS, defined below). But instead of mortgage loans or interest in mortgage loans, the underlying assets may include such items as auto loans, home equity loans, student loans, small business loans, and credit card debt. The value of an ABS is affected by changes in the market's perception of the assets backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans, or the financial institution providing any credit enhancement.

BB and BBB credit rating

Securities and issuers rated AAA to BBB are considered/perceived “investment-grade”; those rated below BBB are considered/perceived non-investment-grade or more speculative.

Central bank

Entity responsible for oversight of a nation’s monetary system, including policies and interest rates.

Collateralized loan obligations (CLOs)

A form of securitized debt, typically backed by pools of corporate loans and their payments.

Commercial paper

Short-term debt issued by corporations to raise cash and to cover current expenses in anticipation of future revenues.

Commodities

Commodities are raw materials or primary agricultural products that can be bought or sold on an exchange or market. Examples include grains such as corn, foods such as coffee, and metals such as copper.

Consumer Price Index (CPI)

CPI is the most commonly used statistic to measure inflation in the U.S. economy. Sometimes referred to as headline CPI, it reflects price changes from the consumer's perspective. It's a U.S. government (Bureau of Labor Statistics) index derived from detailed consumer spending information. Changes in CPI measure price changes in a market basket of consumer goods and services such as gas, food, clothing, and cars. Core CPI excludes food and energy prices, which tend to be volatile.

Corporate securities (corporate bonds and notes)

Debt instruments issued by corporations, as distinct from those issued by governments, government agencies, or municipalities. Corporate securities typically have the following features: 1) they are taxable, 2) they tend to have more credit (default) risk than government or municipal securities, so they tend to have higher yields than comparable-maturity securities in those sectors; and 3) they are traded on major exchanges, with prices published in newspapers.

Correlation

Correlation measures the relationship between two investments--the higher the correlation, the more likely they are to move in the same direction for a given set of economic or market events. So if two securities are highly correlated, they will move in the same direction the vast majority of the time. Negatively correlated investments do the opposite--as one security rises, the other falls, and vice versa. No correlation means there is no relationship between the movement of two securities--the performance of one security has no bearing on the performance of the other. Correlation is an important concept for portfolio diversification--combining assets with low or negative correlations can improve risk-adjusted performance over time by providing a diversity of payouts under the same financial conditions.

Coupon interest rate

The coupon interest rate is the stated/set interest rate that is assigned to each interest-paying fixed-income security when it is issued. It is used to calculate the security's periodic interest payments to investors; the coupon rate is applied to the security's principal value to generate interest payments.

Credit quality

Credit quality reflects the financial strength of the issuer of a security, and the ability of that issuer to provide timely payment of interest and principal to investors in the issuer's securities. Common measurements of credit quality include the credit ratings provided by credit rating agencies such as Standard & Poor's and Moody's. Credit quality and credit quality perceptions are a key component of the daily market pricing of fixed-income securities, along with maturity, inflation expectations and interest rate levels.

Credit ratings

Measurements of credit quality (defined below) provided by credit rating agencies (defined below). Those provided by Standard & Poor's typically are the most widely quoted and distributed, and range from AAA (highest quality; perceived as least likely to default) down to D (in default). Securities and issuers rated AAA to BBB are considered/perceived to be "investment-grade"; those below BBB are considered/perceived to be non-investment-grade or more speculative.

Debt security

A debt instrument, including bonds, certificates of deposit or preferred stocks.

Duration

Duration is an important indicator of potential price volatility and interest rate risk in fixed income investments. It measures the price sensitivity of a fixed income investment to changes in interest rates. The longer the duration, the more a fixed income investment's price will change when interest rates change. Duration also reflects the effect caused by receiving fixed income cash flows sooner instead of later. Fixed income investments structured to potentially pay more to investors earlier (such as high-yield, mortgage, and callable securities) typically have shorter durations than those that return most of their capital at maturity (such as zero-coupon or low-yielding noncallable Treasury securities), assuming that they have similar maturities.

Eurozone

The eurozone is sometimes referred to as the euro area and represents the member states that participate in the economic and monetary union (EMU) with the European Union (EU). The eurozone currently consists of: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Federal Reserve (Fed)

The Fed is the U.S. central bank, responsible for monetary policies affecting the U.S. financial system and the economy.

Floating rate

A floating rate is associated with payments that fluctuate with an underlying interest rate level, as opposed to paying fixed-rate income.

Fundamentals/fundamental analysis

Investment "fundamentals," in the context of investment analysis, are typically those factors used in determining value that are more economic (growth, interest rates, inflation, employment) and/or financial (income, expenses, assets, credit quality) in nature, as opposed to "technicals," which are based more on market price (into which fundamental factors are considered to have been "priced in"), trend, and volume factors (such as supply and demand), and momentum. Technical factors can often override fundamentals in near-term investor and market behavior, but, in theory, investments with strong fundamental supports should maintain their value and perform relatively well over long time periods.

General obligation (GO) bonds

One of the biggest sectors in the municipal securities (defined below) market. Typically, these bonds are secured by the full faith and credit pledge (defined above) of the issuer and usually supported by the issuer's taxing power (tax revenues provide the means by which most interest payments are made). GO bonds can be issued by states, counties, cities, towns and regional districts to fund a variety of public projects, including construction of and improvements to schools, highways, and water and sewer systems.

Gross domestic product

Gross domestic product (or GDP) is a measure of the total economic output in goods and services for an economy.

High-yield bonds

High-yield bonds are fixed income securities with lower credit quality and lower credit ratings. High-yield securities are those rated below BBB- by Standard & Poor's.

Inflation

Inflation, sometimes referred to as headline inflation, reflects rising prices for consumer goods and services, or equivalently, a declining value of money. Core inflation excludes food and energy prices, which tend to be volatile. It is the opposite of deflation (see Deflation).

Inflation-protected securities

Debt securities that offer returns adjusted for inflation; a feature designed to eliminate the inflation risk.

Investment-grade corporate bond or credit

A debt security with a relatively low risk of default issued and sold by a corporation to investors.

Liquidity

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.

Mortgage-backed securities (MBS)

A form of securitized debt (defined below) that represents ownership in pools of mortgage loans and their payments. Most MBS are structured as "pass-throughs"--the monthly payments of principal and interest on the mortgages in the pool are collected by the financial entity that is servicing the mortgages and are "passed through" monthly to investors. The monthly and principal payments are key differences between MBS and other bonds such as Treasuries, which pay interest every six months and return the whole principal at maturity. Most MBS are issued or guaranteed by the U.S. government, a government-sponsored enterprise (GSE), or by a private lending institution.

Municipal bonds

These are long-term municipal securities (defined below) with maturities of 10 years or longer.

Municipal securities (munis)

Debt securities typically issued by or on behalf of U.S. state and local governments, their agencies or authorities to raise money for a variety of public purposes, including financing for state and local governments as well as financing for specific projects and public facilities. In addition to their specific set of issuers, the defining characteristic of munis is their tax status. The interest income earned on most munis is exempt from federal income taxes. Interest payments are also generally exempt from state taxes if the bond owner resides within the state that issued the security. The same rule applies to local taxes. Another interesting characteristic of munis: Individuals, rather than institutions, make up the largest investor base. In part because of these characteristics, munis tend to have certain performance attributes, including higher after-tax returns than other fixed income securities of comparable maturity and credit quality and low volatility relative to other fixed-income sectors. The two main types of munis are general obligation bonds (GOs) and revenue bonds. GOs are munis secured by the full faith and credit of the issuer and usually supported by the issuer's taxing power. Revenue bonds are secured by the charges tied to the use of the facilities financed by the bonds.

Net Asset Value (NAV)

The total value per share of all the underlying securities in a portfolio.

Nominal yield

For most bonds and other fixed-income securities, nominal yield is simply the yield you see listed online or in newspapers. Most nominal fixed-income yields include some extra yield, an "inflation premium," that is typically priced/added into the yields to help offset the effects of inflation (see Inflation). Real yields (see Real yield), such as those for TIPS (see TIPS), don't have the inflation premium. As a result, nominal yields are typically higher than TIPS yields and other real yields.

Non-agency commercial mortgage-backed securities (CMBS)

MBS that represent ownership in pools of commercial real estate loans used to finance the construction and improvement of income-producing properties. Non-agency CMBS are not guaranteed by the U.S. government or a government-sponsored enterprise.

Quality

Nationally recognized statistical rating organizations assign quality ratings to reflect forward-looking opinions on the creditworthiness of loan issuers.

Real estate investment trusts (REITs)

Real estate investment trusts (REITs) are securities that trade like stocks and invest in real estate through properties or mortgages.

Russell 1000® Growth Index

Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with higher price-to-book ratios and higher forecasted growth values.

Russell 1000® Value Index

Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with lower price-to-book ratios and lower forecasted growth values.

S&P 500® Index

The S&P 500® Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.

Securitized debt

Debt resulting from the process of aggregating debt instruments into a pool of similar debts, then issuing new securities backed by the pool (securitizing the debt). Asset-backed and mortgage-backed securities (ABS and MBS, defined further above) and collateralized mortgage obligations (CMOs, defined above) are common forms of securitized debt. The credit quality (defined above) of securitized debt can vary significantly, depending on the underwriting standards of the original debt issuers, the credit quality of the issuers, economic or financial conditions that might affect payments, the existence of credit backing or guarantees, etc.

Senior-secured securities

A security that has a higher priority compared to another in the event of liquidation.

Sovereign debt

A country's own government-issued debt, priced in its native currency, that can be sold to investors in other countries to raise needed funds. For example, U.S. Treasury debt is U.S. sovereign debt, and would be referred to as sovereign debt when bought by foreign investors. Conversely, debt issued by foreign governments and priced in their currencies would be sovereign debt to U.S. investors.

Spreads (aka "interest-rate spreads", "maturity spreads," "yield spreads" or "credit spreads")

In fixed income parlance, spreads are simply measured differences or gaps that exists between two interest rates or yields that are being compared with each other. Spreads typically exist and are measured between fixed income securities of the same credit quality (defined above), but different maturities, or of the same maturity, but different credit quality. Changes in spreads typically reflect changes in relative value, with "spread widening" usually indicating relative price depreciation of the securities whose yields are increasing most, and "spread tightening" indicating relative price appreciation of the securities whose yields are declining most (or remaining relatively fixed while other yields are rising to meet them). Value-oriented investors typically seek to buy when spreads are relatively wide and sell after spreads tighten.

Spread sectors (aka "spread products," "spread securities")

In fixed income parlance, these are typically non-Treasury securities that usually trade in the fixed income markets at higher yields than same-maturity U.S. Treasury securities. The yield difference between Treasuries and non-Treasuries is called the "spread" (defined further above), hence the name "spread sectors" for non-Treasuries. These sectors--such as corporate-issued securities and mortgage-backed securities (MBS, defined above)--typically trade at higher yields (spreads) than Treasuries because they usually have relatively lower credit quality (defined above) and more credit/default risk (defined above), and/or they have more prepayment risk (defined above).

Stagflation

Stagflation describes slowing economic growth combined with high inflation.

Treasury inflation-protected securities (TIPS)

TIPS are a special type of U.S. Treasury security designed to address a fundamental, long-standing fixed-income market issue: that the fixed interest payments and principal values at maturity of most fixed-income securities don't adjust for inflation. TIPS interest payments and principal values do. The adjustments include upward or downward changes to both principal and coupon interest based on inflation. TIPS are inflation-indexed; that is, tied to the U.S. government's Consumer Price Index (CPI). At maturity, TIPS are guaranteed by the U.S. government to return at least their initial $1,000 principal value, or that principal value adjusted for inflation, whichever amount is greater. In addition, as their principal values are adjusted for inflation, their interest payments also adjust.

Treasury note

A treasury note is a debt security issued by the U.S. government with a fixed interest rate and maturity ranging from one to 10 years.

Treasury yield

The yield (defined below) of a Treasury security (most often refers to U.S. Treasury securities issued by the U.S. government).

Valuation

A quantitative estimate of a company or asset’s value.

Yield

For bonds and other fixed-income securities, yield is a rate of return on those securities. There are several types of yields and yield calculations. "Yield to maturity" is a common calculation for fixed-income securities, which takes into account total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity.

Yield curve

A line graph showing the yields of fixed income securities from a single sector (such as Treasuries or municipals), but from a range of different maturities (typically three months to 30 years), at a single point in time (often at month-, quarter- or year-end). Maturities are plotted on the x-axis of the graph, and yields are plotted on the y-axis. The resulting line is a key bond market benchmark and a leading economic indicator.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.