WHEN DOVES CRY
Investors expecting additions to the easing program in Japan were left standing alone in April as the Bank of Japan (BOJ) kept its policy framework unchanged. With inflation still stubbornly low and the yen stronger on the year, the market had priced in a modest probability of further easing prior to the BOJ's meeting. Instead, the yen strengthened sharply in the wake of the BOJ's inaction, similar to what occurred in the aftermath of the January decision to cut the policy rate into negative territory. Some viewed the April pause as a tacit acknowledgment by the central bank that its unconventional policies may be reaching their limits. Whether that is true or not, the BOJ's challenges appear to be growing as the yen's 6% appreciation in April has now left it 13% stronger thus far in 2016.

A calmer tone prevailed in April as a weaker dollar and rising commodity prices sustained global risk appetite, even as major central banks took a pause from significant policy actions. While dovish central banks drove markets higher in March, they took a backseat to other global developments in April as monetary policy remained largely unchanged. In the U.S., the Federal Reserve met market expectations by keeping rates on hold. In the eurozone, the ECB stayed put after expanding asset purchases the month prior, despite downgrading its inflation forecast for the region. The BOJ also held firm, though its decision not to inject additional stimulus took markets by surprise, driving the yen higher and Nikkei lower. Still, global sentiment was bolstered by crude oil prices, which surged to over $48 per barrel even as oil producers failed to reach an agreement to freeze production at a meeting in Doha. With a favorable environment of rising commodity prices and the Fed on hold, positive developments in emerging markets stole headlines: China’s stockpile of currency reserves moved higher after five consecutive months of decline; Argentina made its return to global capital markets in a highly successful debt offering; Brazilian markets rallied on the lower house’s decision to move forward with impeachment proceedings against President Rousseff; and central banks, including India, Turkey and Hungary, took the opportunity to ease policy to help support growth.

While risk sentiment continued to improve across markets, mixed economic data underscored a brittle ‒ though still positive ‒ global growth environment. The advance estimate of U.S. GDP growth in Q1 was soft, though persistent strength in the labor market continued to be supportive of the domestic outlook. Retail sales figures surprisingly declined in April while housing measures appeared a bit muddled, with underwhelming housing starts offset by robust existing home sales. The multi-month rising trend in core inflation measures also stalled a bit as core goods prices declined and growth in service prices slowed. Lackluster data in the U.S. contrasted with better releases elsewhere. In the eurozone, growth measures in both Spain and France outpaced expectations. Even Chinese growth indicators from manufacturing PMIs to industrial production measures were better than feared, as Q1 official GDP was in line with expectations. On balance, the global growth picture remained largely unchanged: slow but mostly steady, with few signs of recession on the horizon.

The market rally gathered steam in April, but with sentiment cooler than the rally would suggest. Commodity prices continued their strong run, buoyed in part by an expansionary impulse from China and a weaker dollar. Oil prices surged more than 20% on the month, boosting exporter currencies in developed and emerging markets. Global corporate credit spreads compressed further on the month, with spreads in nearly every sub-sector tighter than at the end of last year. Equities also ended the month higher while volatility – as measured by the CBOE’s VIX index – posted its lowest monthly average since before the China-induced sell-off in August 2015. This appetite for riskier assets nudged developed sovereign yields modestly higher, with the exception of Japan, where yields fell and the yen strengthened sharply in the wake of the BOJ’s surprise decision to remain on hold. Still, U.S. 10-year yields remained 45 basis points below year-end levels, suggesting more fragility to both market sentiment and the fundamental backdrop than implied by the two-month-and-counting market rally. With somewhat diminished concerns over China, higher commodity prices and continued extraordinary support from global central banks, an uneasy calm lingered in financial markets as the month came to a close.

RISING TIDE LIFTS OIL BOATS
Plunging oil prices weighed on markets in 2015 as growing stockpiles reflected the global supply glut. The new year started with more of the same as prices sank to 12-year lows, but oil prices have since rebounded dramatically. Crude oil prices rallied over 20% in April alone and now stand nearly 30% higher so far in 2016. Separating out energy-linked names in both equities and high yield credit highlights just how much rising oil prices have differentiated returns: energy-related assets have surged since February lows, while non-energy linked names in both asset classes have gained much less. Of course, the non-energy names did not bear the pain of the downturn in oil and so are cumulatively better off over the combined period since 2015.

DEVELOPED MARKET DEBT
Markets continued to recover from the global recession fears and weak sentiment that plagued the first quarter, with developed market yields generally rising over the month as central banks kept policy on hold. Ten-year yields in the U.S., eurozone, U.K. and Canada were higher, while yields on eurozone peripheral debt rose more than those on German bunds. Japan yields fell following the BOJ’s decision to leave monetary stimulus unchanged, a surprise to the many investors who were expecting further easing measures. The ECB downgraded its forecast for inflation but declined to add to its easing program, which nudged rates higher. Data in the U.S. were generally softer, including an advance estimate of first quarter GDP that indicated growth of just 0.5% despite continued underlying strength in the labor market, and the Fed kept interest rates unchanged.

CREDIT
In a robust rally, global investment grade credit¹ continued to outperform like-duration government securities in April, with spreads tightening another 13 basis points (bps). Spreads ended the month at 130 bps, a level not seen since mid-July 2015, effectively erasing the widening that occurred in tandem with falling commodity prices and bringing year-to-date returns to 4.16%.

The rally in global high yield bonds² gathered momentum in April amid a sharply improved backdrop for commodities, better-than-expected U.S. Q1 earnings and an accommodative global central bank landscape. Spreads narrowed by 75 bps, yields fell 70 bps and total returns were higher by 3.50% for the month, bringing year-to-date returns to 6.57%.

EQUITIES
Developed market equities³ ended April up 1.6% thanks to the dovish Fed and a rebound in oil prices. U.S. equities⁴ returned 0.4% amid mixed economic data. In Europe,⁵ equities advanced 2.1% as the ECB continued to emphasize its ability and willingness to do “whatever is needed” to achieve stability. Japanese equities⁶ finished slightly down, returning -0.6% as the yen strengthened nearly 6% in the month, creating pressure for corporations in Japan with U.S. revenues.

In emerging markets,⁷ equities rose slightly, returning 0.5%, driven primarily by a rebound in oil prices. Chinese equities⁸ fell ‒2.2% as reports of an improving economy fueled concerns over a pullback in stimulus from the PBOC. In Brazil,⁹ stocks continued to climb, returning 7.7% as commodity prices advanced broadly and speculation over political change continued. Indian equities¹⁰ rose 1.0% amid expectations of strong corporate earnings.

MORTGAGE-BACKED SECURITES
Agency MBS¹¹ outperformed like-duration Treasuries by 16 bps, as the risk-on tone continued in broader markets and prepayment fears eased. Conventional MBS outperformed Ginnie Mae MBS, amid heavy supply and weak financing technicals. Although bank demand improved, overseas investors remained the only consistent purchaser of Ginnie Mae MBS. 15-year MBS marginally outperformed 30-year MBS, and higher coupon securities outperformed lower coupons, with the conventional 4.5% finishing the month as the best performing liquid coupon securities. Non-Agency MBS was relatively strong as spreads ended the month tighter; market technicals remained favorable, and underlying collateral performance has been stable.

INFLATION-LINKED DEBT
Global inflation-linked bonds (ILBs)¹² posted strong relative performance in April as the rally in commodity prices helped boost inflation expectations across the globe. U.S. breakeven inflation (BEI) began the month by trending down when core CPI moderated slightly to 2.2% year-over-year (yoy) from 2.3% in February. However, bullish momentum for TIPS resurfaced over the latter half of the month with the help of a strong five-year auction and a core PCE (quarter-over-quarter) well above expectations and crossing the Fed’s 2% target. In Europe, BEI levels rallied across countries despite continued softness in inflation readings, with April’s HICP flash estimate at -0.2% yoy. In the U.K., ILBs sold off and lagged nominal gilts. Long-dated ILBs, in particular, were weak ahead of heavy supply scheduled for May.

MUNICIPAL BONDS
Municipals ¹³posted a 10th consecutive month of positive total returns and outperformed Treasuries, driven by constructive technical factors and a supportive macroeconomic environment. New issue supply was down 20% from March levels and primarily consisted of refunding volume. Retail demand remained robust: Investors added an average of over $1.2 billion per week to municipal mutual funds.

The positive technical dynamic outweighed the impact of negative credit headlines, and credit spreads generally tightened during the month. Puerto Rico dominated the negative headlines, as the Commonwealth and U.S. Congress sought debt restructuring solutions to address the island’s fiscal crisis ahead of an expected default of Government Development Bank debt service due in early May. Illinois spreads also widened while the state continued to operate without a budget.

EMERGING MARKET DEBT
Emerging market debt outperformed once more during the month of April. Continued currency strength against the U.S. dollar and lower index yields propelled local debt returns,¹⁴ while spread tightening outweighed the impact of slightly higher U.S. Treasury yields for external bonds.¹⁵ Each regional sub-index within both local and external indexes posted positive absolute returns again in April, with Latin America the standout. Brazil gained again after impeachment proceedings cleared the way for the removal of the president from office. Currencies gained as the Federal Open Market Committee decided against raising U.S. rates, pushing the dollar down broadly, while the continued recovery of global crude oil prices served as a tailwind for the local debt of exporters like Russia and Colombia.

COMMODITIES
Commodities posted strong returns for the month, with some broad-based indexes gaining over 10%. Nearly all sectors and commodities participated in the rally, which was generally supported by a weaker U.S. dollar and greater optimism for global growth. The energy sector was the top performer, led by crude oil and products. Brent crude finished the month $12 higher at $48/barrel as market optimism overshadowed a bit of bearish data over the month. Natural gas was also up on the back of better heating demand prospects. In agriculture, soybeans and corn led the rally supported by adverse weather conditions in South America. Industrial metals benefited from some constructive data out of China, as well as expectations of further stimulus given weak inflation.

CURRENCIES
The U.S. dollar weakened against the majority of developed and emerging market currencies as global central banks paused and left policy on hold. When the BOJ kept monetary policy unchanged instead of easing further, the yen soared, exacerbating concerns about the limitations of unconventional monetary policy. The ECB downgraded its forecasts for inflation in the region but also declined to add to existing easing measures, which strengthened the euro. Meanwhile, the Fed decided to keep rates unchanged, though it did not rule out the possibility of rate hikes this year. The currencies of commodity exporters, particularly in emerging markets like Colombia, Brazil and Russia, climbed with continued strength in oil prices, which neared $50 per barrel.

PIMCO expects global economic and policy divergence will continue to provide a mix of risks, opportunities and volatility. While markets have largely rebounded from the downturn at the beginning of the year, we have lowered our 2016 forecasts for global growth and inflation in light of the weaker economic momentum as well as some tightening in financial conditions at the onset of the year. Importantly, we do not expect a global or U.S. recession over the cyclical horizon. While the three C’s – China, commodities and central banks – have been calmer recently, their paths forward will be key swing factors for the global outlook.

In the U.S., our expectation is for above-trend economic growth in a 1.75%–2.25% range in 2016. We expect the “delicate handoff” from slowing job growth to higher wages to succeed as the main driver of income creation, supporting further gains in consumer spending. Assuming a gradual lift in crude oil prices by year-end, headline inflation (as measured by the CPI) is likely to hover in the 1.0%–1.5% range before rising to 2% by year-end. With PCE inflation (personal consumption expenditures inflation, which is expected to run about 0.5% below CPI inflation) remaining below the Fed’s 2% target and global developments still posing considerable risks to the outlook, we expect the Fed to move cautiously, raising rates only once or twice this year.

For the eurozone, we anticipate trend-like GDP growth in the 1.0%–1.5% range.We expect the headwinds for growth from weak global demand and the tightening of financial conditions earlier this year to be roughly offset by the lagged effects of the weaker euro on exports, and for low oil prices and rising employment to support consumption. The ECB’s March easing package should also be mildly supportive for growth. Yet, with inflation likely to continue to undershoot the ECB’s objective of “below but close to 2%,” further easing later this year may be in the pipeline.

Japanese GDP growth will likely be in the 0.25%–0.75% range in 2016. With China slowing and the benefits from past yen depreciation petering out, the external sector will continue to be a small drag for economic activity. Inflation looks set to continue to fall short of the BOJ’s 2% target – our forecast is for headline inflation in a range of 0.25%–0.75%. Against this backdrop, we anticipate further easing measures by the BOJ during the year.

Our outlook for China is for growth in a 5.5%–6.5% range and headline inflation around 1.25%. China’s transition from “old” (industrial, state-owned and export-oriented) to “new” (service sector, private and consumption-oriented) growth drivers continues to sputter. As such, we expect “official” GDP growth to fall short of the government’s 6.5%–7% target range for three reasons: room for monetary policy easing is limited as it could accelerate capital outflows and put downward pressure on the yuan; the government seems unwilling to meaningfully expand fiscal policy; and volatility in the equity market and overcapacity in the property market have increased uncertainty, weighing on consumer confidence.

We expect BRIM growth will be in line with consensus at 0.75%–1.25% India is forecast to grow at a 7.3% pace this year, about the same as last year, while Mexico should see a slight acceleration to 2.8% growth this year. In Brazil, the political situation remains fluid with many market participants suggesting that a regime change could provide a catalyst for reforms. In Russia, we think the sharp adjustment in unit labor costs presents an opportunity to rebalance the economy longer term, and a further recovery in oil prices would help to end the current recession.

IN SIGHT PROMESA'S PROMISES
As expected, Puerto Rico defaulted on the majority of a $422 million payment due at the beginning of May for its Government Development Bank (GDB), the fiscal agent that lends to the island’s agencies and municipalities. This is Puerto Rico’s first major default and comes after Governor Padilla invoked a debt moratorium law passed in April. The default pushes the U.S. Congress, which has been slow to move in addressing the commonwealth’s crisis, to act quickly. The U.S. House Natural Resources Committee is working on a bill that would establish a federal oversight board to manage the island’s fiscal and legislative affairs as well as any debt restructurings. The bill will likely stop coupon payments and create a stay on litigation for some period of time. The default also puts pressure on creditors to negotiate a broad consensual debt restructuring. Puerto Rico’s next large scheduled debt service payment is on July 1, when $1.9 billion is due across different entities including the general obligation. The governor has stated that the island cannot pay all of it and we expect Puerto Rico’s cash needs will grow more acute heading into the summer. Puerto Rico bonds continue to trade near their lows.