Russel Matthews, portfolio manager, European bond strategies at BlueBay Asset Management, explains how markets are holding firm amidst a cacophony of geopolitical unrest, central bank meetings and a flaring banking crisis.
It was a ‘quietish’ week in financial markets last week. Quite remarkable considering the last time we reported there had been a coup attempt in Turkey, an European Central Bank (ECB) meeting and ongoing speculation over whether or not the Italian government would be able to come up with an acceptable patch for the Italian banking system.
Core government bond markets have largely moved sideways and very short dated US rates have repriced the probability of a Federal Reserve interest rate hike in 2016 meaningfully higher. Corporate bonds have continued to perform well as the insatiable demand for yield is unabated, with spreads compressing in all sectors.
A team consisting of our financials sector and macroeconomic policy specialists were in Brussels last week to sound out EU policy makers on how they are progressing on dealing with the Italian banking sector headache. Our view is there will ultimately be a pragmatic solution for the shortfall in Italian capital that prevents retail investors from taking any losses.
However, the mood music in the EU capital was not all that constructive. We believe there seems to be a lack of urgency and we have come away with the impression that stress may need to rise somewhat in the near term before a satisfactory outcome is delivered.
Over the medium term, we remain constructive that there will likely be a solution delivered to ease the stress from nonperforming loans and regulatory pressure on the banks.
Rate and sovereign credit have had a good run of late but the question we are asking ourselves is are we at the point where policy makers and investors have become complacent?
Our mantra has always been that policy makers are likely to be lazy and under deliver if there is no pressure from markets. We have been through two major risk events in the last six weeks (Brexit, Turkey) and risk assets have continued to perform.
We expected and anticipated this outcome, but that does not prevent us from becoming uneasy at the level of calm that we are witnessing, and the growing confidence that the market has with policy makers.