Rise in Portuguese yields shows central bank monetary policy is not the only risk, says BlackRock’s Thiel

BlackRock’s deputy CIO of Fundamental Fixed Income Scott Thiel comments on the ECB announcements and global themes.

• For the second month in a row, the European Central Bank (ECB) kept the main refinancing rate unchanged at 0.5% and the marginal lending rate and deposit facility remain at 1.0% and 0% respectively.

• The rhetoric in the subsequent press conference was quite dovish. Furthermore, in a shift in communication strategy, President Draghi explicitly indicated forward guidance stating that they expect “the key ECB interest rates to remain at present or lower levels for an extended period of time”. The linkage of this forward guidance to the inflation outlook, monetary dynamics and the economy is significant. We recently added front end Italy positions and are short the euro versus the US dollar, both of which benefited from a fall in the EUR/USD rate and tightening of peripheral spreads on the news.

• The turmoil that fixed income markets experienced in May continued throughout June. Volatility remained high and yields across all sectors from ‘risk-free’ government bonds to investment grade, high yield and emerging markets generally ended the month higher than where they started. The yield on the 10 year US Treasury increased from 2.13% at the end of May to 2.48% one month later1.

• The interest rate selloff was primarily caused by a backup in risk-free rates after several FOMC members commented on the prospect of a reduction or ‘tapering’ of quantitative easing (QE), which is currently running at a total $85 billion of treasury and mortgage purchases per month. Since these initial comments, investors have focused on key data points and announcements pertaining to US growth and unemployment, looking for signs on the timing of the commencement of the QE tapering. FOMC meetings and payroll data have become particular focal points for market observers.

• We remain short US duration and have a positive view of both the US economy and the dollar over the medium term. We view the new domestic energy supply as very supportive over the medium term, while household wealth is already improving as the housing market appears to be recovering and the stock market has risen (although the sequester is dampening some of the economic data).

• As such, ahead of the non-farm payrolls data announcement on 7th June, we increased our short US duration position (sold 10 year US treasuries). The actual number was robust and given the resulting sharp selloff in treasuries we took profit on some of this position to reduce risk whilst remaining short duration. This positioning also performed strongly in the aftermath of the FOMC meeting two weeks later on 19th June, when a more hawkish than expected tone from Chairman Bernanke, including improved projections for the unemployment rate and growth, caused another rapid decline in treasury prices.

• The sharp rise in Portuguese government bond yields over the last couple of days, in the wake of the resignation of two of the country’s senior cabinet members, serves as a timely reminder that central bank monetary policy is not the only risk to fixed income markets. It is likely that problems within the Eurozone will also once more come increasingly to the fore as the German general election looms closer and growth and unemployment in the region remain at problematic levels.

• Finally, the Bank of England Monetary Policy Committee (MPC) today voted to keep the key interest rate and Asset Purchase Programme size unchanged. This was the first meeting with Governor Mark Carney at the helm and, significantly, in a break from convention a statement was released which stated that “the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy”. He has a huge job on his hands and for now we retain our negative view of the UK given the political stalemate, continued above target inflation and anaemic growth and we therefore remain short sterling.

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