Santander AM: Euro Fixed Income outlook 

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Adam Cordery, global head of European Fixed Income, Santander Asset Management, and fund manager for the Santander Euro Corporate Short Term and Euro Corporate bond funds comments on the euro fixed income market outlook for September.

The focus of policy everywhere now is QE. The longer this goes on, the more households and firms will become dependent on low rates, the harder it will become to hike again and the more likely it is that the market will price in the idea that rates might not just be “lower for longer” but “lower forever” (or at least “lower-for-as-long-as-rates-have-been-low-in-Japan”).

In this environment, corporate spreads and yields are likely to stay compressed as they are today, and stock selection will probably be the way to add value. With credit spreads low, and bund yields low, there is little margin for error, and big deviations from benchmark positions are probably not being well-rewarded.

The potential for fund managers to get caught the wrong side of a “sanctions trade” has gone up, and the penalties are stiffer than those applied from simple underperformance.

This is new territory for current generations of bond fund managers who, generally speaking, haven’t had to worry very much about such things. Trading geo-political uncertainties has got harder.

I think the spread rally in the eurozone periphery has probably run its course by now, and market pricing is now in a fair-value channel. If peripheral sovereign spreads go substantially tighter from here, the sensitivity of spreads to political/economic setbacks will increase and profit-taking probably becomes more likely among the fast-money holders.

The bund market is probably due a correction having moved in a straight line down all year so far. However, I doubt any correction is the start of the normalisation many in the market are looking for. Indeed, it would not be extraordinary to see the 10-year yield regularly dipping, or staying, below 1% in the coming months if – as seems likely – shorter-dated bund yields stay near to zero.

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