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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Welcome to the TCW Investment Perspectives Podcast, where
our investment professionals share their insights and
expertise on how to make the most of your portfolio.
Today, we are focusing on global fixed income markets, following a steady stream
of policy changes and executive orders from the new Trump administration.
Every day seems to bring a new development,
and TCW is keeping close watch on it all.
Here today to discuss the impact of all these pronouncements on
global markets is Anisha Goodly, a Managing Director and Global
Portfolio Specialist here at TCW, and Blaise Antin, also a TCW
Managing Director and Head of the Sovereign Research Team.
So, Blaise, let's start with you.
The recent Munich Security Conference underscored a growing
divide between the US and Europe on a number of issues.
So, what were your key takeaways and what do
you think the future holds on this front?
These are great questions, Dave, and really, where to begin?
I guess I would start by saying it seems to me that the
second Trump administration has embraced the long-standing
Silicon Valley mantra to move fast and break things.
We've never seen a US administration conduct foreign
policy or really any policy in the way we're seeing now.
Second and specific to US foreign policy and geopolitics, at the risk of
sounding melodramatic, I think the first and most important point to make here
is that the transatlantic alliance, just short of its 80th birthday, was dealt
an enormous blow in Munich, maybe even a fatal blow, some have suggested.
Vice President Vance's direct attacks on European standard of democracy
and free speech parameters really shocked his European audience.
And I think it also shook European leaders out of their misplaced
optimism that Trump 2.0 might closely resemble Trump 1.0.
That was an impression that had begun to take hold, I think, in late January
when Trump announced big tariffs on Canada and Mexico, and then delayed them
for a month in response to quite minor concessions from Trudeau and Scheinbaum.
In any event, Vance's speech, along with Ukraine hostile
remarks by Defense Secretary Pete Hegseth, came on
the back of that long Trump-Putin phone conversation.
And then this high-level U.S.-Russia bilateral meeting in Saudi
Arabia, which created the very clear impression about a reset of
Washington-Moscow relations at the expense of both Ukraine and Europe.
So what's going on here?
I think, as I said, this is really potentially a real break in U.S.
foreign policy, something that we haven't
seen since the end of the Second World War.
For markets, I think a lot of people are wondering
if this is just about the art of the deal.
And in fact, that may in fact be true, but there are many experts in
the international relations and geopolitics space who believe we're
witnessing a shattering of the fundamental norms that have governed U.S.
foreign national security and international
trade policies for the last eight decades.
And to this point, I would say, first month of the second
Trump administration, clearly foreign policy represents
a real rupture from what we've seen for so long.
Deploying an untested and high-risk approach to mixing carrots
and sticks across a range of diplomatic instruments, including
resource nationalism, trade tariffs, foreign aid, U.S.
troop presence on foreign soil, and even potential redevelopment
of current war zones, it's not entirely clear what the strategic
endgame is, but President Trump's tactics are highly unconventional.
Negotiations with other countries are likely to be very low transparency,
a fact which makes life harder for markets, and with prospects for
sanctions or tariff relief, along with lucrative contracts all in play.
There's a lot going on.
All right.
So clearly a lot of stuff going on, lots of changes in certainly in U.S.
approach, but not a lot of response in markets.
Why do we think the markets haven't responded as strongly as you
might've expected, given the dramatic shifts we've seen in policy?
So as Blaise has highlighted, we're in the early days
of this geopolitical decoupling between the U.S.
and Europe, and there's a pretty wide distribution
of outcomes with pretty limited transparency.
If we focused on global fixed income, the initial market reaction
was a sell-off in European government bonds, really reflecting the
potential for increased debt issuance to fund defense spending.
But that said, even though it seems pretty clear to us that the
Europeans are supportive of increased defense spending, which
Blaise you can expand upon, the rates move hasn't been significant.
We would certainly caution that that could change by the time that this is out
there, and these markets move pretty quickly, but really not a significant move.
Now if you look at the currency markets, I think what's also interesting
is that the risk premium in FX vol markets has actually been
declining, right, in the face of all of these headlines.
So again, to us this really reflects the high level of uncertainty
in sequencing risk, which makes it really difficult for the market
to price in just one potential outcome when there are so many.
All right, so we've covered the outcomes from the conference in Munich.
Obviously there's a lot of other things going on outside of that.
What are some other potential policy shifts that might be coming out of Europe
as a consequence of what's happening in Washington or elsewhere in the world?
Dave, I would say that the European policy response is a work in progress, in
part because of European uncertainty regarding Trump's preferred end game.
The two main areas of likely European policy response
will come in the forms of defense spending and tariffs.
On defense spending, it's now clear to everyone in Europe
that defense spending must continue rising as a share of GDP.
Trump has urged 5% of GDP spending on national defense
by all NATO members, a level which significantly exceeds
all current NATO members, including the United States.
In general, I would say that European NATO members will likely
target an increase from their current defense spending levels around
2% of GDP to between three and three and a half percent of GDP.
This is achievable, but funding such spending
increases will require some big policy changes.
Most importantly in Germany, the constitutional
debt break will have to be amended.
In our base case, this will happen before or by mid 2025, but the specifics
of how this happens will depend very much on the outcome of German elections.
More generally, it would be preferable for a big ramp up
of EU member country defense spending to be funded at
the EU level rather than solely at the national level.
There's precedent for this with prior EU bond issuance to support
the 27 member countries COVID pandemic response a few years ago.
Our base case is that the EU will get to shared issuance one way or the
other in support of higher defense spending, but this could take longer,
probably will take longer than the German specific debt break issue.
On the European response to US tariffs, which are coming, many investors
have been surprised to this point that President Trump hasn't hit
Europe or the EU yet with a specific and painful tariff threats.
Everyone expects this, and Trump did in fact just talk about 25% tariffs on auto
imports, which would represent a direct threat to German car makers and their
large supply chain providers, especially in Central and Eastern Europe.
EU trade negotiators have been publicly floating a range of preemptive
moves in EU policy to head off potentially painful US tariffs.
This could include lower EU tariffs on US autos and auto parts, less onerous
EU regulatory burdens on large tech companies, and more of that sort of thing.
At the same time though, the EU is also making clear that it will punch
back quickly with counter tariffs on any new US tariffs that get levied.
EU tariffs would likely go after US sectors and producers that are
domiciled in US red states, which might be able to more effectively
lobby the Trump administration to find compromises more quickly.
All right, so that's a good summary of, I
think, some of the defense side of things.
What other foreign policy initiatives or concerns does the
team have, and what are you looking at elsewhere in the world?
Picking up off of what Blaise said, there is this question
about whether the EU will start to re-import Russian gas.
To put some numbers to this, prior to the war, the EU was the
principal buyer of Russian oil and gas, importing about 40
to 45% of its gas and 25 to 30% of its oil from Russia.
That quickly pivoted after February of '22 as the EU shifted
to other suppliers, many within the emerging markets.
Now we think that the EU might be more willing to indicate willingness to ramp
up purchases of US energy exports, especially LNG, as well as military supplies.
But at this point, a pivot back towards Russian energy dependence
seems like an extreme and unlikely outcome in our view.
We don't necessarily see Europe undermining their own geopolitical interests
in search of cheaper energy, as much as they may want cheaper energy.
But this is something that we do have to monitor, because if they do pivot in
this direction, which isn't really priced in, and again, in our view, more of
an unlikely outcome, it would benefit the consumer, it would benefit
growth, and it would also, in some way, lower inflation pressures.
Now, away from Europe, there's really been no shortage of headlines.
So Panama, Greenland, Colombia.
But I think what we want to highlight is one of our other sovereign research
analysts, Brett Rowley, just came back from a two-week visit to the Middle East.
And it was really interesting timing, because he was
there before and after the headlines around Gaza.
So just to put this in perspective, this is a region
that has among the best credit fundamentals in emerging
markets, but as we know, presents geopolitical risk.
Like Ukraine, the Middle East has benefited from the perception
of reduced geopolitical risk under a Trump administration.
Lebanon was the best performing sovereign last year in the EM Index.
Bonds were up over 100% from fairly distressed levels.
And a lot of that got priced in later in the year.
Now, our analyst, Brett, was there, as I mentioned, before and after these
headlines and around these statements around whether, you know, the U.S.
would be owning Gaza and relocating
Palestinian refugees to both Egypt and Jordan.
And so one of his key takeaways was how quickly sentiments shifted from general
support of the Trump administration to pretty sharp rebukes from all across the
Middle East, most notably Saudi Arabia, where the kingdom has
expressed firm and unwavering support of a Palestinian state.
At this point right now, it's unclear whether
this is Trump's way of encouraging negotiations.
But in fact, in a few weeks, Egypt, Jordan, Saudi Arabia, Qatar and the UAE
will meet to discuss how to rebuild Gaza without displacing Palestinians.
From a markets perspective, those countries that are close to Gaza, Egypt
and Jordan sold off after the announcement, but in our view would bounce
back after there could be some signs of a more of a homegrown solution.
But I think stepping back when we think about the region overall, there is
a very strong desire to boost non-oil growth and really increase tourism.
And that's going to hinge on improving regional security, which
could be more likely because Iran has been significantly weakened
as well and appears a little bit more willing to negotiate.
So that's something else that we're watching.
Great.
Thanks.
So Blaise touched on this a little bit earlier, but I don't think
we can talk about the current state of the global economy and
the outlook without addressing sort of the elephant in the room.
And that is the tariffs that have either been discussed or
imposed or threatened, but haven't been fully implemented
yet, as well as the reciprocal tariffs that might come.
Obviously, there's a lot of moving pieces there and they
affect countries from Canada and Mexico to Europe and China.
What's the current state of the world and where do we see things going?
What makes this a difficult question to answer is that it's not entirely
clear what the Trump administration's tariff policy objective is.
Some days the emphasis seems to be equalizing trade imbalances.
Some days it's about raising tax revenue for the U.S.
budget.
Some days it's about coercing non-U.S.
companies to invest more into their U.S.
manufacturing capacity.
And some days it's about non-economic objectives like illegal
immigration or illegal drug flows, especially fentanyl.
One month into the new administration, prioritizing U.S.
objectives remains unclear.
And this leaves the rest of the world to
freelance a bit when it comes to how to respond.
And all of this, of course, in a context where the world's experience with
Trump 1.0 was that President Trump would open up every negotiation with
maximalist demands before his team ultimately found
its way to some sort of middle ground compromise.
While hopes for a benign compromise are out there, U.S.
industry is understandably nervous about how this UMCA tariff war will play out.
In the meantime, the lack of transparency and the high degree of
policymaking incoherency has sort of a nerd markets to what's going on.
And that's in a world where markets typically are known for hating uncertainty.
You know, on China, I think what's interesting
here is that for so long during the U.S.
campaign, we heard about 60% tariffs on China.
And the initial 10% tariff announcement was
obviously by extension much lower than expected.
The more recent U.S.
threats about tariffing Chinese exports to the U.S.
in auto, steel, aluminum, semiconductors, pharmaceuticals,
represent less than half of 1% of Chinese GDP.
So to this point, the Chinese response to the U.S.
moves and policy statements has been fairly muted.
To us, this demonstrates a Chinese willingness to engage in
deescalatory negotiations to the extent that's possible.
We'd also expect U.S.-China negotiations to be drawn out though, even
as they potentially result in Chinese commitments to import U.S.
products and sectors that the administration
deems important, such as agriculture.
We also have to keep in mind the Chinese domestic policy reaction function.
We see real potential for increased Chinese
stimulus to counteract the impact of U.S.
tariffs and to support growth in China.
Such stimulus appears most likely to come via higher consumer spending.
I would say, for example, in trade-in programs
for old autos or old home appliances.
In downside tariff scenarios, China could, of course,
once again, allow the yuan to depreciate, limiting the
competitiveness loss facing Chinese exporters to the U.S.
market, and probably enraging China hawks in the Trump administration.
You know, Nisha, maybe you want to step in
on how markets are thinking about this.
Sure, Blaise.
So I think similar to what we discussed before, it's hard to price in
too much at this point, and markets are mostly in wait-and-see mode.
On the bright side, we're almost seeing no evidence
of any buyer strike across global emerging markets.
EM sovereigns, quasi-sovereigns, corporates, and banks have all been
able to issue in size during the first six weeks of this year, even
during weeks when there have been some pretty significant
announcements, whether about tariffs or geopolitics.
You know, I'll give you an example.
Even Uzbekistan, a low BB sovereign, a relatively new issue to the market.
They just issued a two-tranch deal, so both
in dollars and euros, inside current pricing.
Now, on the local market side, EM countries, local auctions have also
been enjoying strong demand, well in excess of targeted issuer side.
I think a lot about what we talk about here, and we can expand on this later, is
just how, even if credit spreads across the board are tight, valuations in EM
still look attractive relative to the U.S., and so you are seeing a
good amount of crossover buyers come into the market in our space.
But again, more broadly speaking, we think the
market will adjust once there is more clarity.
All right, so it sounds like we're in a situation of pretty significant
policy uncertainty, but actually fairly resilient markets through all this.
So with all that in mind, what's the team doing from a portfolio standpoint?
Has their perspective on risk changed?
And how are you positioning portfolios these days in recognition
of all the things that we don't know about what's going to happen?
Sure.
So at a high level, even with all of these headlines, EM growth is
on track to outpace developed markets growth at close to the widest
spread relative to the past decade, which is pretty healthy.
EM upgrades are outpacing downgrades, a very real
reflection of improvement in the asset class.
And look, while credit spreads, again, may be at the tighter end of
the range versus history, EM, in our view, offers relative value.
So to put some numbers to this, EM investment
grade is 30 basis points wide to U.S.
investment grade.
EM high yield sovereigns are over 200 basis points wide to the U.S.
But look, that's just really at a high level.
If we really want to, you know, when we think about just portfolio
construction overall, we're very much focused on differentiation, right?
We've talked about tariffs today.
We've talked about various geopolitical risks in the market.
This isn't necessarily, in our view, a beta trade on emerging markets.
It's really thinking about, okay, how are each
of these countries impacted by these changes?
Now, we're not necessarily positioning our portfolios for Trump tariffs or Trump
geopolitical risks, but we're focused a lot on looking at every single sovereign
and corporate in the portfolio and credit to the sovereign research team and the
corporate research team to understand what those
outcomes look like under various scenarios.
What's our base case?
What's our downside case?
What is our upside case?
And so what we're doing in the portfolio in particular is focused
on bottom up, right, while navigating those top-down risks.
And so, again, focusing on those issuers with strong idiosyncratic
drivers that can navigate through some of this volatility.
Blaise talked earlier about, you know, the industries and their response.
You know, we're watching for corporate uncertainty and what
that may mean for credit spreads, and we're drilling down,
looking at individual sectors to see what the impact may be.
And then I think the other thing I would just mention is that in terms of
dollar debt relative to local currency debt, which is a question that we
get fairly often in the near term, we're much more focused on dollar debt.
And that is more because of our more near-term view that the dollar
may trade with the premium, but doesn't necessarily negate our
longer-term view that the dollar is likely to weaken over time.
All right.
Thank you both.
Clearly, lots of uncertainty that needs to be
sorted out here in the next couple of months.
Needless to say, we here at TCW will be paying close attention to all
these developments and implications for markets around the world.
I'm sure we'll have more to say on the topic
in our future podcast and other commentary.
Thank you, Anisha and Blaise, for speaking with me today.
For more information on TCW strategies, please visit our website at tcw.com.
Thanks for listening, and we'll pick up next time, exploring
more trends and opportunities that are shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit tcw.com/insights.
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