BlackRock’s Thiel: European bond market following ECB measures- caution needed
Scott Thiel, deputy CIO of Fundamental Fixed Income and head of the Global Fundamental Fixed Income Team, comments on the ECB announcement.
The measures announced by the European Central Bank (ECB) are very important. Among a raft of changes to their monetary policy stance, here are four of the most important. First, they reduced headline policy interest rates, including cutting the main refi rate to 0.15% and making the deposit facility rate negative at -0.1% making it the first major central bank to charge commercial banks for depositing money with it.
Secondly, President Draghi indicated that the ECB is working hard on plans to potentially implement some form of asset purchase plan (ie. QE) for asset backed securities (ABS). He made it very clear that members of the governing council are unanimous in their support for additional unusual monetary policy tools.
Thirdly, he announced new targeted longer-term refinancing operations (LTROs) and, finally, the ECB will no longer sterilise the liquidity created by its Securities Markets Programme. Both the new LTROs and the potential ABS purchases should be positive for European banks, which would support our long-standing view of being overweight subordinated bank debt.
Concern has been growing, both by market commentators and the ECB itself, over the low level of inflation in the eurozone, which remained at the very low level of 0.5% in May (source: Eurostat). In their new staff forecasts, inflation was revised down for the next three years. They now expect it to very gradually rise to 1.4% in 2016. Changes to GDP forecasts were mixed; with the outlook for 2014 reduced to 1.0% while 2015 was raised to 1.7%.
While we remain positive overall on the European periphery, we are cautious in the current environment and our positions in the region are now at their lowest levels in over two years. We are cognisant not only of the recent spread compression for peripheral European government bonds but also the switch in market focus from fundamentals to the potential for QE in the eurozone.
Holding Portuguese government bonds was a long-standing position for us over the past few months – we entered the position with the view that the valuations did not reflect the country’s improving fundamentals. A few weeks ago, however, we took profit on this position, given the strong compression that we witnessed in these bonds.
We have retained some long positions in Spanish sovereign bonds versus Italy, which we currently favour on a relative value basis. We believe Spanish yield spreads may continue to tighten versus other peripherals driven by positive momentum and long-term fundamentals.
In general, we are cautious towards the current global bond market environment. We see the potential for volatility and liquidity issues to arise once markets begin to focus on the large imbalances that have occurred from rates being so low for such a very long time, particularly by the Fed and the Bank of England.
Among our active currency views we remain long GBP and short JPY. This is our preferred expression for further divergence between the British and Japanese economies and their respective monetary policies. We also remain short CHF vs EUR as we expect to continue to see an unwinding of safe haven trades.
Finally, we continue to like local currency bonds in selective emerging market economies, namely India, South Africa, Turkey and Brazil. We believe that inflation has peaked and domestic demand is now weak enough for these central banks to stop raising rates. Regarding India in particular, the concerted efforts of the RBI and the government have helped to reduce the economy’s external vulnerabilities. In addition, we have a positive view of the smooth running and decisive outcome of the recent national election.