- Financial markets, so far this year, have been dominated by a cocktail of robust and/ or improving economic data from a range of G7 sources juxtaposed against political risk, uncertainty and rhetoric. As such, developed market stock markets have rallied significantly (the S&P 500 hit a record high) and the US 10-year treasury yield increased to above 2.5%, while the British pound and Mexican peso have both bounced in wide ranges against the US dollar year to date.
- In this environment we believe that flexibility, diversification and a strong focus on risk management are extremely important both to generate alpha and to protect portfolios.
- As expected, the ECB left key interest rates and its monetary policy stance unchanged today. The amount of asset purchases will fall from €80bn to €60bn per month, as planned, from next month.
- The ECB also reiterated that they expect their key interest rates “to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases”. However, during the press conference, President Draghi qualified the opening statement commenting that the balance of risks to growth has improved and that the probability of deflation has subsided, although he denied in the Q&A that an exit from QE had been discussed. The ECB’s HICP inflation forecasts for 2017 and 2018 have been revised up to 1.7% (from 1.3%) and 1.6% (from 1.5%) respectively.
- In our view, the tone of the Q&A was more hawkish than the introductory statement and more hawkish than market consensus. As a result, the probability of any further easing has been materially downgraded. This underscores our thesis of short pan-European rates.
- The market is currently focusing on the upcoming French election as one of the key risks for bond markets. We are not underestimating the risks, given how tight the race appears to be and the groundswell of populism that took many investors by surprise in the UK’s referendum on the EU and the US election. If Marine Le Pen were to win that would have enormous ramifications for the euro, the eurozone and the EU. We are short French government bonds as a hedge against French-specific risk.
- Elsewhere in Europe we have a range of diversified positions. We have short duration positions in Hungary, the Czech Republic and Poland, hold Italian inflation-linked bonds and, in the corporate bond space, have a preference for subordinated debt (particularly in financials). We also remain long the Swedish krona.
- Regarding the US Federal Reserve, we do believe in the reflation trade and it is our view that the Fed may raise interest rates three times this year. The market has significantly repriced its view of the timing and pace of US interest rate normalisation to now anticipate a hike in March, which we agree with, however, in our opinion, not enough is priced in for 2018 and 2019. All eyes will be on the employment data released tomorrow (10th March). We are positioned with a US curve flattener.
- Finally, in emerging markets, we continue to focus on idiosyncratic opportunities. These include positions in India, Korea, Brazil and Argentina.
Insights and Resources
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