ECB to complete Asset Quality Review before launching QE, says BlackRock

BlackRock’s fixed income team has reviewed the four key themes it outlined at the beginning of 2014 in light of markets’ performance in Q1.

Benjamin Brodsky, global head of fixed income asset allocation; Stephen Cohen, chief investment strategist international fixed income and iShares EMEA; Michael Krautzberger, head of the Euro fixed income team and Owen Murfin, portfolio manager on the global bond portfolio team met again to provide an update on how the year has kicked off for the asset class they invest in.

“There’s no doubt that fixed income markets have changed. The search for yield endures, but decades-long notions of safety and consistency have had to be re-evaluated. [The themes we have outlined at the beginning of the year] have been playing out as we thought, especially our expectations for improved total returns for the asset class in 2014 following the yield curve steepening of 2013. So where do we go from here?” they said.

Looking at central bank policy divergence, the team highlights that the major central banks – BoE; Fed; ECB and BoJ – still seem to work on two different tracks, with the first two slowly moving from highly accommodative to more normal policy, while the second two seem to be considering different forms of quantitative easing.

“An exit from QE will be extremely challenging and reducing global liquidity will have unintended consequences across all assets,” the team said.

More specifically, BlackRock’s managing directors for fixed income said they expect the BoE to be the first of the world’s four major central banks to raise interest rates, potentially as early as the first quarter of 2015; the Fed to continue to place a greater emphasis on the path of both inflation and the labour market while it tapers; the ECB to remain accommodative, given ongoing questions over further potential policy options and the strength of the euro.

“The results of this year’s Asset Quality Review will be assessed ahead of any contemplation of its own version of QE,” they said.
Assessing what asset classes have proved successful in the first quarter of the year, Brodsky added that credit cycle remains benign given low corporate default rates and plenty of liquidity.

“The credit cycle is doing very well,” he said, “and this is very important as it is a mirror for broader economy. However, as we highlighted at the start of the year, we are seeing an increase in event risk, particularly in the US,” he adds.

“The releveraging of non-financial balance sheets has been accelerating. It was noted that M&A activity in both the US and Europe had picked up significantly in recent weeks, with previous releveraging trends more focused on stock repurchases and dividend increases.

“While capex levels remain disappointing, the releveraging theme was expected to continue bolstered by high CEO confidence and cheap financing levels. Improved equity valuations also meant that equity can be issued as an acquisition currency,” Murfin added.

The European periphery and the ECB stress tests

Commenting on the imminent ECB’s Asset Quality Review across eurozone’s banks, Murfin said that the stress tests, while not being very effective in the past, are realistic now and will be very helpful in re-establishing trust in banks within the continent.

“The tests could certainly be more extreme, however they are definitely very helpful to raise the degree of trust and will definitely be very useful to us. Moreover we are receiving very positive stories from many of the European banks, especially from Spain and Portugal,” he added.

On when to expect more stimulus from the ECB, Krautzberger says that he does not think it will happen any time before June. “I expect more traditional measures before the summer. If QE is going to happen, it will be later this year,” he said.

Emerging markets
Tackling another of the four key themes, spotting the differences in emerging markets, the fixed income team give an outlook of where the value lies in the area. While being certainly defensive in Russia, Brodsky says that the situation is still fluid and they would rather judge on numbers than on events.

“Valuation in EMs looks still relatively cheap, activity in the developed world has sped up especially thanks to the recovery of fundamentals in the US, which could become a significant headwind for the area if interest rates rise suddenly. However, we do need to see a more sustainable trend of growth in emerging markets. For instance, we are still expecting China’s GDP growth to pick up,” he said.

Commenting on the company’s recent purchase of the Greek government bond, the team specifies that they are looking at Greece with interest and that they still consider it a periphery country, rather than as an emerging market as many have started to do, but they still expect the country to prove its accountability.

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