Advisory Blog
Economic Insight: 2019 outlook

Timely insights on the issues that matter most to investors.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Vishal Khanduja, CFA, Calvert Fixed Income Portfolio Manager and Brian S. Ellis, CFA, Calvert Fixed Income Portfolio Manager

      Boston - Now that the peak effects of fiscal stimulus are behind us, our outlook for the U.S. economy has become somewhat less optimistic. That said, we expect GDP to grow at a solid pace over the next few quarters, underpinned by a strong consumer. We also believe the U.S. economy will continue to outperform other major developed economies.

      While our base-case forecast doesn't call for a U.S. recession in 2019, domestic economic data has softened coming off of above-trend growth in the second and third quarters. In addition, financial conditions have tightened considerably, leaving the Federal Reserve with less work to do. Nonetheless, we still think markets may be underpricing the Fed's rate path. Outside the U.S., we are watching the European Central Bank (ECB) for further progress on policy tightening.

      Clearly, the direction of Fed policy is more uncertain than it was when the economy was accelerating and financial conditions were more benign. This increases the risk of a policy mistake that could impact our economic forecast. History has shown that the Fed has a poor track record of normalizing policy, and the current cycle could be even more difficult given how unorthodox monetary policy has been.

      Blog Image Central Bank QT Jan 28

      Geopolitics are having a bigger impact, and we believe markets will remain more sensitive to these issues as global central banks continue to tighten. In Europe, the Italian populist movement remains a concern but less of a near-term risk in light of the government's recent budget compromise with the European Union (EU). Meanwhile, worries about Brexit have flared up as the March 29 deadline approaches.

      Of course, China will likely remain the key geopolitical risk facing markets, and we think the China story is much more dynamic than simply a goods-exchange trade war. In our opinion, the bigger and more important piece is the theft of intellectual property (IP), cybertheft by Chinese state actors, and how the utilization of Chinese-sourced equipment might compromise key defense and industrial targets. This is why the U.S. is closely scrutinizing Huawei and other Chinese providers, and why the "trade war" may not be settled any time soon.

      As we entered 2019, portfolios remained slightly underweight interest-rate duration through the intermediate part of the curve on the view that markets have become too complacent on the path of Fed rate hikes. Portfolios also maintained exposure to Treasury Inflation Protected Securities (TIPS) as a hedge against inflation. Headline inflation will likely decline because of lower oil prices, but we believe core inflation will gradually move higher, albeit at a slower pace than it did in 2018.

      With respect to sector allocations, we continue to overweight asset-backed securities that are sensitive to housing and household balance sheets but are monitoring the impact of higher interest rates on the consumer. Lower gas prices and wage increases should help offset the effects of higher rates. However, the total U.S. macro impact of the drop in oil prices is uncertain given the negative implications for capital investment and employment.

      The recent sell-off in credit has created more opportunities throughout the curve. We have selectively increased exposure to investment-grade floating-rate securities whose spreads are materially wider than their fixed-rate counterparts. In several cases, these are callable securities trading below par that appear to have a good chance of getting called. We have also increased exposure to bank loans in portfolios that invest in high-yield debt. Volatility in the bank loan market has been technically driven by flows, and valuations imply default rates that we believe are not fundamentally justified.

      Bottom line: Risk markets had a tough end to 2018. However, we do not view the selloff as a harbinger of particularly difficult times ahead for U.S. investment-grade credit. Yes, we expect to see more negative idiosyncratic credit stories. But we are not anticipating significant broad-based market weakness. That said, we recognize investors are less tolerant of higher leverage this late in the credit cycle. So we are proceeding with caution and maintaining our focus on bottom-up security selection, which we believe will be a key driver of portfolio returns in 2019.