The expert magazine of Ostrum AM

Second quarter economic stats ended up confirming investors’ fears from the end of last year of a slowdown in growth worldwide triggered by the US – where fiscal stimulus is waning – along with a trade war that eased for a time but still severely dented trade volumes.

This environment is good news for the fixed-income markets overall, particularly as inflation forecasts are falling across the board. Sluggish core inflation is now encouraging the central banks to maintain or even heighten their financial repression by managing their yield curves, thus extending the growth cycle. The assurance of low interest rates over a prolonged period of time is driving investors to seek out yield without any real distinction between risks and with increasingly high duration: an analysis of investment flows most definitely reflects a clear failure to take a discriminating approach for the moment.

There is an increasingly stark resemblance with the Japanese scenario, and dwindling inflation forecasts from the OECD are increasing the similarities.

Peripheral debt outperforms

 

The swift deterioration in the growth outlook on the financial markets triggered a quest for safe havens, lifting sovereign debt and taking the US 10- year close to 2%. Renewed pressure on risk premiums in May was short-lived, and expectations of a rate cut from the Fed took over, inverting the curve as the US 2-year eased to 1.8%. Meanwhile on the European bond market, yield on the German 10-year also dipped to revisit its 2016 historical lows at -0.3%, while the French 10-year hit 0%. Minutes from the ECB meeting confirmed the TLTRO III program for September, and Draghi’s comments at Sintra further heightened the current feeling that interest rates are set to stay low for a long time to come. Despite macro-financial and political risks in Italy, peripheral and Italian debt in particular outperformed in the euro area, especially on the long end of the curve. The Spanish 30-year has posted absolute performances of almost +20% over the past quarter, far outstripping European stock-market showings. For once, yields on the Greek 5-year moved below the Italian performance this quarter. The ECB is now determined to keep interest rates low and could even start to ease monetary policy again or crank up bond purchases if further risks emerge. Meanwhile the Fed has clearly embarked on a cycle of interest rate cuts while also easing off on its balance-sheet runoff until September, which means close to $16bn in sovereign debt for purchase on the market each month. There is an increasingly stark resemblance with the Japanese scenario, and dwindling inflation forecasts from the OECD are increasing the similarities. Central banks are increasingly moving away from their fundamental purpose – safeguarding the value of their currency – whereas financing the economy at a low cost and keeping strong liquidity in the system to maintain financial stability have become the main priorities. Investors have grasped this, and they are using this implicit guarantee to march on with purchases across all asset categories despite ‘risk-free’ remuneration becoming increasingly negative. Geopolitical and financial risks are having little impact on investors’ herd behavior. We think that for now it is important to keep an eye on investment flows but be more discerning in selecting debt in the third quarter. The ECB is now determined to keep interest rates low and could even start to ease monetary policy again or crank up bond purchases if further risks There is an increasingly stark resemblance with the Japanese scenario, and dwindling inflation forecasts from the OECD are increasing the similarities. emerge. Meanwhile the Fed has clearly embarked on a cycle of interest rate cuts while also easing off on its balance-sheet runoff until September, which means close to $16bn in sovereign debt for purchase on the market each month. There is an increasingly stark resemblance with the Japanese scenario, and dwindling inflation forecasts from the OECD are increasing the similarities. Central banks are increasingly moving away from their fundamental purpose – safeguarding the value of their currency – whereas financing the economy at a low cost and keeping strong liquidity in the system to maintain financial stability have become the main priorities. Investors have grasped this, and they are using this implicit guarantee to march on with purchases across all asset categories despite ‘risk-free’ remuneration becoming increasingly negative. Geopolitical and financial risks are having little impact on investors’ herd behavior. We think that for now it is important to keep an eye on investment flows but be more discerning in selecting debt in the third quarter.

We think that for now it is important to keep an eye on investment flows but be more discerning in selecting debt in the third quarter.

Buoyant outlook for emerging debt


We maintain our broadly long duration stance on OECD sovereign debt, particularly the US and EU, and still underweight the very long end of the US curve, as well as Italy where growth and budget discipline are still disappointing. Positive sentiment on most emerging debt should increase as the US dollar weakens, thereby substantiating our positive outlook on this segment, particularly on Mexico, Brazil, Peru, Indonesia and Poland. Lastly, the markets have already well and truly priced in concerns on the suspense surrounding trade negotiations between Washington and Beijing. However, the fall-out from a conflict in the Gulf or a disorderly Brexit in the fall are not entirely factored in. All these factors could revive risk aversion in the third quarter of the year, but still not reverse the main trend on interest rates, unless oil revisits its highs.

The fall-out from a conflict in the Gulf or a disorderly Brexit in the fall are not entirely factored in.

Horizons - Q3 - 2019 - EN

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