Madrid, 15 July 2019: The US economy celebrated its longest period of expansion on record in June. Government bond markets however seem to disagree with the optimism shown by risky assets, with yields that reached multi-year lows and inflation expectations that remain on a downward trend.
In this month’s outlook, Andrea Iannelli, Investment Director, Fidelity International, discusses the dovish stance from central banks with rate cuts and quantitative easing back on the menu:
"The dovish stance that most central banks have turned to this year, on the back of trade wars and weak manufacturing data, lies at the heart of this disconnect and of the broad rally across all markets, as investors’ reach for yield resumes".
Preference for US Treasuries
“Our long duration stance remains in place, with a preference for US Treasuries. While our view was out of consensus earlier in the year, it is hardly so now, with 10yr yields below 2%. Wary of a replay of the moves in mid-2015, when government bond yields rebounded strongly in the space of a short period of time, we are watching market positioning very carefully, for any sign of a turnaround. Politics and inflation are particularly on our radar. The G20 brought a temporary resolution to the trade spat. However, a comprehensive deal that removes all tariff hurdles is still unlikely in our view, with little room for compromise from either side and structural differences and issues between the US and China that are still unresolved.
Bunds to remain well supported
“Over in Europe, QE and rate cuts are now back on the agenda. We pared back some of our short duration exposure over the quarter, particularly in core and semi-core, and now are only marginally underweight. In core markets, German Bunds are likely to remain well supported by the ECB’s dovish rhetoric, with the flattening trend that is likely to continue. Arguably there is the risk that the ECB backtracks from its dovish stance, with the market pushing Bund yields higher as expectations of an imminent QE are priced out. While this scenario would be similar to what we saw in 2015, there are a few differences that make it unlikely at this stage.
“Firstly, the ECB postponing QE is more likely to impact risky assets, and in turn inflation expectations, with safe haven demand and lower breakevens in turn supportive for Bunds. Secondly, looking at the parallel with 2015, the move higher in yields was driven by an uptick in inflation, which the market interpreted as a sign that the QE programme was finally working. Compared to 2015, the inflation picture is even more challenging and inflation expectations remain subdued. Moreover, fresh QE, if implemented, is expected to be in the region of 30bn EUR per month, a fraction of the amount deployed at the peak of balance sheet expansion, and unlikely to impact the inflation outlook.
“Peripheral government bonds benefitted from the rush for yield in June. Italian BTPs in particular traded strongly since the ECB QE headlines and might have some more way to go. We remain sceptical as to whether Italy is out of the woods yet, for several reasons. Firstly, QE might not come as early as the market expects, especially if macro data does not deteriorate from here and there is some détente in the US/China trade war. Secondly, should QE indeed be restarted, it might embolden the Italian government in their negotiations with the EC this Autumn. Lastly, QE 2.0 may only be politically possible with additional clauses attached, to prevent aggressive issuance to fund government deficits. To balance our BTP underweight in a strong risk environment we added to other peripheral and semi-core government bonds, which provide a good level of carry while exposing us to lower political hurdles in the months ahead.
Gilts remain expensive
“Lastly in the UK, the BoE joined the chorus of other dovish central banks and acknowledged that rates could be cut if the macro picture does not improve. Gilts remain expensive on a relative-value basis, but we keep a neutral stance given the absence of a strong view and the strong momentum that persists across all rates markets.”
Note to editors
Fidelity International offers world class investment solutions and retirement expertise. As a privately owned, independent company, investment is our only business. We are driven by the needs of our clients, not by shareholders. Our vision is to deliver innovative client solutions for a better future. We invest £235.5bn globally on behalf of clients in 26 countries across Asia-Pacific, Europe, the Middle East, and South America. Our clients range from central banks, sovereign wealth funds, large corporates, financial institutions, insurers and wealth managers, to private individuals. In addition to asset management, we offer investment administration and guidance for employer benefit schemes, advisers and individuals in several countries. We are responsible for £81.7bn in assets under administration. Data as at 31 March 2019.Any opinions expressed are made at the time of writing and can be subject to change without notification.
