Liquidity support powering fixed income, says JPMAM’s Gartside

LTRO driven liquidity is providing a positive environment for fixed income, particularly in the eurozone, says Nick Gartside of JP Morgan Asset Management.

The international CIO for fixed income (pictured) said “In 2012 to date, risk assets have powered ahead, with US equities reaching levels not seen since before the collapse of Lehman Brothers in 2008. The reason for this strong performance is the level of liquidity in the system. In February, the European Central Bank’s second long-term refinancing operation (LTRO) saw 800 banks take up a total of €530bin in three-year funding – and this follows the injection of €489bn in the first LTRO in December. Since the introduction of the LTRO, risk appetite has improved dramatically. Italian two-year bond yields had spiked to 7.5% back in November, with concerns mounting over Italy’s ability to refinance its debt. In early March, the same bond was yielding around 2%, and Italy is on target with its refinancing over the year to date.”

The ECB’s effects on liquidity are compounded by further quantitative easing from the Bank of England, which announced a further £50 billion of QE in February, and from the Bank of Japan, which unexpectedly announced ¥10trn of additional QE and introduced a new 1% inflation target, which is expected to require yet more asset purchases. Meanwhile rates are being cut in emerging markets and China has reduced the reserve requirement ratio for its banks. In sum, this global trend represents the biggest increase in liquidity since 2009.

Gartside signals out high yield as particularly attractive, with strong fundementals. Default rates are low by historical standards, while companies are finding it easy to roll over debt given the high number of investors entering the asset class. The euro market is seen as particularly attractive due to currency-weakening liquidity injections benefitting exporters among the high-yield companies. Meanwhile Gartside argues that lower debts and defecits make emerging markets a good buy, leaving them at less risk of default.

However, Gartside stressed that such liquidity injections are not without risk.

“One way to think of the LTRO is as a drug. The drug has done a good job of healing the patients – indebted European sovereigns and the ailing European banking sector – in the short term, but the long-term impact might be that of many drugs: addiction. Investors will need to keep a watchful eye on the ability of weak banks and sovereigns to wean themselves from central bank dependence.”

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