2017 Market Outlook - Global Fixed Income

GLOBAL FIXED INCOME

Quentin Fitzsimmons

Portfolio Manager

November 17, 2016

2017 Global Market Outlook Press Briefing

2

Global Fixed Income Outlook: Summary

ENVIRONMENT

Historically low yields continue to be evident in many international fixed income markets, pointing to divergence away

from the U.S., where policy rates are being very gradually increased. Around the world, political patience with

accommodative monetary policy is wearing thin as economic growth remains low. More generally, investors are

questioning the balance between monetary and fiscal policy and how a greater reliance on the latter may impact fixed

income opportunities. (At the same time, the rebound in the price of oil is causing subdued inflation rates to base and

challenge fixed income valuations for many.)

LOOKING AHEAD

The interplay between slow but discernible monetary policy tightening in the U.S. and a firm anchoring of Japanese

and core European bond yields suggests significant opportunities to exploit the move in spreads between

international markets as well as the shapes of yield curves.

Global investors will continue to get rewarded for blending different country cycles together, especially in sovereign

opportunities that may be less familiar in traditional benchmarks. This reflects the value of fundamental research that

tracks improved public debt management and institutional transparency and further reform potential (notably in

Eastern Europe and parts of Asia).

Credit markets remain supported by central bank balance sheet expansion and purchase programs as well as the

abeyance of the energy market scare. If volatility also remains suppressed in this environment, security selection can

be fruitful.

The recovery in oil and some other commodity prices has helped to improve the potential for better economic

performance in some developing countries such as Brazil and Mexico. Embedded value is often accessible via the

currency market.

3

Challenges Facing Fixed Income

Investors: The Subzero-Yield Landscape

As of September 30, 2016

Sources: Bloomberg Barclays Global Aggregate Bond Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission.

T. Rowe Price.

EVOLUTION OF GLOBAL FIXED INCOME MARKETS

GOVERNMENT YIELDS 1YR 2YR 3YR 4YR 5YR 6YR 7YR 8YR 9YR 10YR

Japan

Switzerland Negative Yield

Germany Positive Yield

Sweden

Netherlands

France

Belgium

Spain

Italy

Australia

Canada

UK

U.S.

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2010 2011 2012 2013 2014 2015

AVERAGE YIELD TO

MATURITY FALLING

0%

5%

10%

15%

20%

25%

30%

Dec-1

4

Ma

r-1

5

Jun

-15

Se

p-1

5

Dec-1

5

Ma

r-1

6

Jun

-16

Se

p-1

6

PROPORTION OF SECURITIES WITH

NEGATIVE YIELD INCREASING

GLOBAL BONDS

GLOBAL BONDS

4

The Global Monetary Policy Experiment Persists…

but Fiscal Expansion Seems More Wish Than Prediction


Sources: Bloomberg Barclays Global Aggregate Bond Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission.

T. Rowe Price.

CENTRAL BANK BALANCE SHEET

(U.S.$ BILLION EQUIVALENTS)

STRUCTURAL BUDGET BALANCE

-7

-6

-5

-4

-3

-2

-1

0

1

2

2001 2003 2005 2007 2009 2011 2013 2015 2017

% P

ote

nti

al G

DP

Advanced

Emerging

0

1,000

2,000

3,000

4,000

5,000

6,000

2000 2002 2004 2006 2008 2010 2012 2014

U.S.

Eurozone

Japan

China

5

Different Government Bond Markets

With Different Yield Curves


Sources: Bloomberg Finance L.P. and T. Rowe Price.

U.S. TREASURY YIELD CURVE JAPAN GOVERNMENT YIELD CURVE

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y15Y20Y25Y30Y

September 30, 2017 (market implied rate)

September 30, 2016

September 30, 2015

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y15Y20Y25Y30Y

September 30, 2017 (market implied rate)

September 30, 2016

September 30, 2015

Further flattening expected. Steep yield curve to remain.

6

Europe: A Big Cloud Forming

on the Horizon?


Sources: Bloomberg, Bloomberg Barclays Euro Aggregate Corporate Index, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used

with permission. T. Rowe Price.

Tapering of

QE Program

European

Elections

UK—

Article 50

EXPECTED IN 2017

-2%

0%

2%

4%

6%

8%

10%

2007 2008 2009 2010 2011 2012 2013 2014 2015

5-Year Germany

Euro Corporate Bonds

5-Year Italy

YIELD TO MATURITY OFFERING

LITTLE PREMIUM

7

Moderate Inflation Continues to Support

Many Bond Markets



0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

202

0

202

1

Asia

Eastern Europe

EXPECTED INFLATION IN

EASTERN EUROPE AND ASIA

BOND MARKET: LOCAL PERFORMANCE

2016 YEAR TO DATE

IMF

FORECASTS

3.0%

5.7%

5.5%

7.4%

9.4%

5.5%

0% 2% 4% 6% 8% 10%

Poland

Romania

Hungary

Malaysia

Philippines

Thailand

8

Not All Parts of the Bond Markets Will Follow

the Same Pattern in a Rising Rate Environment


Past performance is not a reliable indicator of future performance.


MARKET PERFORMANCE WHEN TREASURY

YIELDS ROSE 100 BASIS POINTS OR MORE

12-Months

Ended

U.S. Yield

Move

U.S.

Treasury

Bonds

U.S.

Corporate

Bonds

U.S. Core

Bonds

Emerging

Markets

Corporate

Bonds

Emerging

Markets Hard

Currency

Bonds

U.S. High

Yield Bonds Bank Loans

Dec. 31, 1999 +179 bps -2.6% -2.0% -0.8% – 24.2% 3.4% 3.6%

May 31, 2004 130 -2.6 -0.4 -0.4 3.1 3.1 13.2 7.5

Jun. 30, 2006 120 -1.7 -2.2 -0.8 1.0 4.6 5.1 6.2

Dec. 31, 2009 162 -3.6 18.7 5.9 37.5 28.2 58.9 52.5

Sep. 30, 2013 140 -2.1 -1.6 -1.7 -0.1 -4.3 7.1 5.1

Reference

Index

10-Year

Treasury

Yield Move

Bloomberg

Barclays

U.S.

Treasury

Bond Index

Bloomberg

Barclays

U.S.

Corporate

Investment

Bond Index

Bloomberg

Barclays

U.S.

Aggregate

Bond Index

J.P. Morgan

CEMBI

Broad Index

J.P. Morgan

Emerging

Market Bond

Global Index

J.P. Morgan

Global High

Yield Index

S&P/LSTA

Performing

Loan Index

9

Corporate Bonds: Less About Credit Beta

and More About Credit Alpha



0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

2007 2008 2009 2010 2011 2012 2013 2014 2015

U.S. High Yield

U.S. Investment Grade

Euro Investment Grade

CREDIT YIELDS NEAR THEIR LOWS IMPACT FROM ENERGY PRICES

10

20

30

40

50

60

70

80

90

100

1103.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

2013 2014 2015

U.S. High Yield Premium

Oil Price

Op

tio

n-A

dju

ste

d S

pre

ad

U.S

.$ p

er B

arre

l Yie

ld t

o W

ors

t

Yield to worst close to lows. Option-adjusted spread vs. oil prices (inverted).

10

A Preference for European High Yield

and Bank Loans



0%

5%

10%

15%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

U.S. High Yield

Euro High Yield

U.S. Loans Only

DEFAULT RATES: HISTORY AND EXPECTED

MOODY’S

BASELINE

FORECASTS

11

Near Term, U.S. Dollar Remains Supported




-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

2009 2010 2011 2012 2013 2014 2015

INTEREST RATES DIFFERENTIAL FAVORS U.S. DOLLAR

U.S. dollar tends to strengthen vs. euro

when U.S. rates increase vs. German rates

EUR/USD Spot Germany—U.S. 2-Year Yield Differential

12

But Emerging Markets Currencies Are Likely to

Show Further Appreciation in the Medium Term



Sources: Haver Analytics and T. Rowe Price.

-2%

-1%

0%

1%

2%

3%

2000 2002 2004 2006 2008 2010 2012 2014

Emerging Markets Average CurrentAccount Balance (% of GDP)

Four-Quarters Moving Average

IMPROVING CURRENT ACCOUNTS A STRONG APPRECIATION POTENTIAL

BASE 100 = DEC. 31, 2007

20

30

40

50

60

70

80

90

100

110

120

2007 2008 2009 2010 2011 2012 2013 2014 2015

Russian Ruble

Brazil Real

Mexican Peso

Indonesian Rupiah

DEPRECIATION

TREND

RECENT

APPRECIATION

13

Finally, Is Volatility the Next

Risk on the Horizon?

Sources: Bloomberg Barclays, Bloomberg Index Services Ltd. Copyright 2016, Bloomberg Index Services Ltd. Used with permission. J.P. Morgan and T. Rowe

Price. *Merrill Option Volatility Index (MOVE) **CBOE Volatility Index (VIX)

0

10

20

30

40

50

60

70

80

90

2006 2008 2010 2012 2014 2016

Ind

ex

Le

ve

l

45

70

95

120

145

170

195

220

245

270

2006 2008 2010 2012 2014 2016

Ind

ex

Le

ve

l

TREASURY BOND YIELD VOLATILITY*

September 30, 2006–September 30, 2016 S&P 500 OPTION VOLATILITY**

September 30, 2006–September 30, 2016

DEUTSCHE BANK CURRENCY VOLATILITY INDEX

September 30, 2006–September 30, 2016

10Y Avg.

91

60

10Y Avg.

21

13

10Y Avg.

10

10

5

10

15

20

25

2006 2008 2010 2012 2014 2016

Ind

ex

Le

ve

l

FX Volatiltiy IndexFX Volatility Index

14

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2017 Market Outlook - Global Fixed Income

Economy & Finance

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