Par Marilyn Watson, Head of Global Fundamental Fixed Income Strategy – BlackRock
Comments on today’s ECB meeting and global fixed income themes. Positioning relates to the Global Bond Team.
- 2018 has in many ways been an unsettling year for global financial markets. The vast majority of sectors within the global bond universe, ranging from global government bonds through to high yield, have delivered negative returns year-to-date (as of 13th December).
- After starting with a positive tone, the year has been peppered by idiosyncratic events, most of them politically driven, some of which rumbled on throughout the year such as Brexit and US trade policies. Others included the formation of a new government in Italy and its subsequent budget deficit proposal, elections in Brazil and Mexico, the US mid-term elections, external funding issues in Turkey and Argentina and geopolitical events in the Middle East.
- Against this backdrop, global economic growth has remained above trend but with greater dispersion between regional economic activity than we had anticipated, with the US powering ahead while economic growth in Europe has been weaker than expected.
- With robust GDP growth in the US, the US Federal Reserve (Fed) maintained a steady cadence of quarterly rate hikes this year and the market is pricing in one more hike next week. Next year we anticipate a pause in US interest rate tightening as the Fed becomes increasingly data dependent. As such, we remain long or overweight the front-end of the US Treasury curve and retain our preference for assets that offer attractive risk-adjusted carry.
- As expected, the ECB today maintained key interest rates at current levels and retained its language around not expecting to change them “through the summer of 2019”. It also announced an end to their quantitative easing programme and issued new forward guidance relating to the reinvestment of maturing bonds, including the announcement that reinvestment will continue for an extended period after the first interest rate hike.
- The ECB has lowered its forecasts for inflation and GDP growth for the eurozone in 2019 to 1.6% and 1.7% respectively. In addition, outlining some of the risks to the single currency bloc’s economy, President Mario Draghi noted during the press conference that these include the threat of protectionism, financial market volatility and geopolitical risks.
- Economic growth in the eurozone has slowed against a backdrop of deteriorating trade conditions, tightening financial conditions and growing political risk in some areas. We believe the ECB will maintain a cautious and measured approach to removing its very loose monetary policy stance.
- In terms of positioning, we retain a small long position in Italian government bonds, are tactically short German Bunds and hold select positions in European corporate bonds.
- In the UK, we expect the Bank of England will keep Bank Rate unchanged at 0.75% on 20th December. However, we believe the market is underpricing the possibility of an interest rate hike next year.
- The Bank of England published both its Financial Stability Report and a report on possible Brexit-induced scenarios for the UK economy on 28th November. Questions raised during Governor Mark Carney’s press conference and the press coverage afterwards were largely focussed on the latter report, which showed a decline in GDP growth in all of its Brexit models but included a worst-case scenario in which GDP growth declined by 10.5% by the end of 20231.
- The outcome of Brexit is anything but certain and political events have continued apace. After cancelling a vote in Parliament scheduled for 11th December, Theresa May survived a confidence vote yesterday (12th December) on her leadership of the Conservative Party by 200 votes to 117. Meanwhile, the European Court of Justice has ruled that the UK could simply cancel Brexit if it chooses to without requiring any agreement from the rest of the European Union.
- Turning to the Bank of Japan, we expect it retain its easy monetary policy stance for some time with inflation remaining relatively subdued. We retain our short Japanese duration position.
- We continue to favour certain spread assets for income generation. We remain tactical in corporate bonds and securitised assets, with a strong focus on bottom-up fundamentals and a preference for holding names that offer attractive risk-adjusted carry.
- Finally, we hold select positions in emerging market debt. While we appreciate the ongoing risks for the sector, including tighter global financial conditions, trade and other issues, some of the idiosyncratic tail risks have dwindled and valuations are overall more attractive following the repricing of the past few months.
- Bank of England, 28th November 2018