We are entering a new environment of monetary policy dispersion, says BlackRock’s Thiel
Scott Thiel, Deputy Chief Investment Officer of Fundamental Fixed Income and head of the Global Fundamental Fixed Income Team, comments on last week’s ECB and MPC announcements.
Without a shadow of doubt, 2013 was an extraordinary year for global fixed income markets. Indeed, many government bond markets experienced a rare negative total return for the year. Nevertheless, while the yields on 10-year treasuries and gilts rose by roughly 1% last year, they are still at very low levels compared to historic standards.
Last year we witnessed unprecedented monetary policy stimulus from many of the world’s most influential central banks, including an enormous increase in quantitative easing by the Bank of Japan. Now, importantly for bond markets, we are entering a new environment of monetary policy dispersion between the major central banks, with not only diverging policies but also different objectives. For us, this creates some very interesting investment opportunities including our short gilt and treasury positions.
Under Draghi’s leadership, the European Central Bank (ECB) has continued to proactively support the single currency bloc, both through rhetoric and measures such as reducing interest rates to an historic low of 0.25%. Despite some problems bubbling up, including volatility around the outcome of the Italian election and the Cypriot banking system requiring a bailout, our strong positive belief in the survival and healing process of the eurozone continued to be rewarded last year. It is notable that no country requested help from the Outright Monetary Transactions (OMT) programme, many investors repaid the LTROs early and peripheral spreads continued to narrow overall. Furthermore, Ireland has exited the troika aid programme.
The ECB and the Bank of England both kept their main interest rates unchanged.
In the press conference, ECB President Draghi emphasised that they “will maintain an accommodative stance of monetary policy for as long as necessary”. He also noted that they expect the “key ECB interest rates to remain at present or lower levels for an extended period of time”. He emphasised that the ECB is ready to act if we witness an unwarranted tightening of short-term money markets or worsening of the medium-term inflation outlook. The EURUSD rate fell sharply following these comments. We think it likely that they will announce a new long-term refinancing operation in the first half of this year.
Questioned about whether the eurozone crisis is over, Draghi said that he would be very cautious and that it would be premature to declare victory yet. He suggested this caution is one reason why they have firmed up their language around forward guidance.
President Draghi also noted the importance of the banking union to restore confidence. In the question and answer section of the press conference he stated that an unhealthy banking system hinders the effective transmission of monetary policy.
We remain short or underweight German Bunds in our portfolios and currently we prefer to express our positive views of the periphery via Portugal, Slovenia, Ireland and Italy.
Investors’ expectations and readings of US monetary policy significantly impacted fixed income markets last year. The suggestion at the start of the summer that the US Federal Reserve could start to reduce its huge asset purchase programme earlier than many investors expected caused high levels of market volatility, a rapid selloff in emerging market debt and a rise in treasury yields.
The Fed eventually announced in December that it would begin to ‘taper’ or reduce its asset purchase programme. In our view, under the leadership of Janet Yellen, the Fed will be more transparent and will have a very clear focus on US economic data releases.
We also believe that the Fed is now trying to express a distinction between extraordinary monetary policy tools, such as QE and the use of forward guidance, and interest rates. We remain short US Treasuries and UK Gilts on the belief that the yields on these ‘risk-free’ rates will continue to rise.