Old Mutual’s Cowley says Mario Draghi “likely to disappoint” markets this week
Mario Draghi told markets in July to believe him that his plans to save the euro “will be enough”. But as he prepares to outline the detail this Thursday, fund managers are replying, “it will not be enough”.
Stewart Cowley (pictured), head of fixed income at Old Mutual Asset Managers is the latest to say he believes Draghi will fail to calm markets.
The European Central Bank president has suggested previously that his favoured path to relieve borrowing pressure on troubled Eurozone nations, and thus avert a partial disintegration of the euro, is to target short-dated debt.
The ECB buying would ideally cap yields, and mean countries such as Italy and Spain would not have to follow Greece and Ireland in requesting central aid.
Cowley said: “The markets will hate [what he outlines], and it will not be big enough or dramatic enough and will set off default”.
He noted the markets were unimpressed when the United States Federal Reserve took a similar path, in its first round of quantitative easing.
“The Fed admitted it had done it wrong with QE early on. They bought short-dated debt, which the markets hated because the fear was the Fed was pumping up the money supply, which is inflationary in the minds of markets.
“The yield curve steepened, and long-term rates rose, and we all knew [the Fed] would have to recant on that, and they began buying long-dated debt.”
Cowley said the European Central Bank president did not want either “the credit or duration risk” of troubled nations’ bonds inside the ECB.
Cowley forecasts yields on long-term Spanish and Italian sovereigns will rise again, as markets digest the implication of Draghi’s plans.
“We see another wave of problems coming out of Europe in the fourth quarter,” Cowley said.
“It will also be the signal for the euro to start declining once more, after it had a pause over summer.” Cowley said the common currency should be at 115 to 120 versus the US dollar, whereas it is 125 now.
“The potential for it to fall 10% is definitely there.” The total return mandates Cowley’s team oversees own no euros.
His strategies do have short positions in Bunds, instruments whose overvaluation Cowley says is now “even more ridiculous” than that of shares in Facebook – which have lost over half their value inside four months of their IPO.
(Cowley notes potential for bond markets to move with “equity-style” sharpness inside one day at present.)
He has complemented Bund shorts recently by shorts also on French sovereigns.
Cowley says Nicolas Sarkozy lost the French presidential election in April because his policies were more realistic than victor Francois Hollande’s, who “cannot deliver” on what he has offered voters.
Over summer French debt has traded at 60bps over Bunds, but it had been pushed out to spreads over twice that wide.
Although Cowley has “aggressive” shorts on French and German paper, he has equally high-conviction longs elsewhere, and says: “Because of the capital risks associated with being on the wrong side of the market, we do not think we should be taking directional trades. [What we have] can deliver something, without having to have the ideological position of whether you are inflationary or deflationary.”
Cowley put long positions on gilts and US Treasuries relative to his Bund shorts just as German debt yields hit their lowest point recently, as investors sought ‘safe’ harbours from the unfolding Eurozone crisis.