Francesco Sandrini is Head of Multi Asset Securities Solutions.
This is the second in a series of blogs in which we analyze the main inflation drivers investors should pay attention to in 2017 and beyond, as well as investment opportunities to deal with higher inflation across fixed income, equity and multi asset.
During periods of reflation, global equities, credit and commodities have historically outperformed. Is it okay for investors to assume this will still be the case? In our view, the answer is not straightforward. When considering how to modify portfolio construction to play the reflation theme, we believe investors should consider the evolution of real interest rates, namely how the Federal Reserve will react to higher inflation in the US. Continue reading
1. UK & Article 50 – “It’s the End of the World as We Know It”
Last week, following a bit of back-and-forth between the lower House of Commons and upper House of Lords, legislation was introduced that allows UK Prime Minister Theresa May to trigger Article 50, and thus start the long-awaited process of the UK’s disengagement from the EU. The House of Commons rejected some House of Lords amendments, which had included guaranteed rights for EU citizens in the UK, and an amendment allowing Parliament a ‘meaningful vote’ on May’s negotiation terms with the EU. March 29th has been earmarked as the day that Article 50 will be triggered, 279 days after the UK voted to leave the EU and a few days after the EU celebrations to mark the 60th anniversary of the EU’s founding treaty on March 25th in Rome. Notification of the triggering will happen via a letter from May to European Council President Donald Tusk. As if that’s not enough excitement, Scotland’s First Minister Nicola Sturgeon called for a second Scottish independence referendum before the UK leaves the EU. On top of that, nationalist politicians in Northern Ireland are calling for a referendum on a United Ireland to be held “as soon as possible”. The possibility of the end of the United Kingdom is growing larger by the week. Meanwhile the prospect of another Scottish referendum adds to the complexity of UK Prime Minister May’s task – as one commentator noted, “it’s hard to negotiate a trade deal when you don’t know what territories you’re negotiating on behalf of”. Given the electoral timeline in Europe (with a new German government not likely to be in place before end-2017), it’s difficult to see how any real progress will be made in negotiations until then.
In the End, No Surprise
After the annus horribilis in which several elections resulted in unexpected outcomes (admittedly, without the much feared negative impact on asset prices), we have now had a result that is in line with recent polls and will not lead to a tremendous change in the policy and political approach of the country involved. That said, a negative repercussion is the fragmentation across parties (also expected) which will likely be a source of instability and difficulty for the government. Continue reading
Ken Taubes is Chief Investment Officer, US.
Even while hiking interest rates today, the Federal Reserve Board (Fed) maintained its dovish sentiment. In recent weeks, Fed members began signaling that rate hikes would come sooner, raising expectations for a more hawkish Fed stance. Despite the rate increase, the Fed maintained its emphasis on the need for accommodative policy and gradual rate increases even as the US economy has essentially achieved the Fed’s key targets for GDP growth, inflation and unemployment. In fact, since their rate hike in December, US financial conditions have eased. The short end of the curve still offers negative real yields despite full employment, above trend growth and rising inflation conditions. And the economic stimulus promised by the Trump administration has already started to take effect through executive orders rolling back regulations and supporting investment. Given these clear improvements and the upward trajectory of both the US and global economies, the Fed risks falling further behind, potentially requiring greater rate increases in the future that could destabilize the markets and economic growth.
1. ECB Meeting
24 hours. That’s the time it took the ECB hawks to break ranks and confirm what most of us suspected – that the ECB Governing Council had discussed a rate hike at the previous day’s meeting. Despite a relatively dovish statement and opening remarks at the post-meeting press conference, the tone turned hawkish as ECB President Draghi was asked if the ECB had considered the possibility of raising the deposit rate before the end of Quantitative Easing (QE). Draghi tried his best to dodge the question, “refusing to speculate” and noting that the forward guidance is “an expectation” and based on “current information”. As we noted in our blog on Thursday, we have seen enough press conferences and speeches from Draghi to know that if he didn’t answer the question, it’s because he wants to keep his options open. And sure enough, on Friday afternoon newswires quoted “people familiar with the matter” as saying that ECB Governing Council members exchanged views on ways of communicating and sequencing an exit from unconventional stimulus. Asking not to be identified because the deliberations were private, ECB officials noted that the Council did not discuss any specific scenario or timeline and hasn’t made any formal decisions on a strategy. We suspect the leak was from the northern faction of the ECB, given that headline inflation is Germany is currently running at 2.2%, and that Bundesbank members have been vocal in calling for a removal of the extraordinary monetary policy stimulus. Remember that Draghi, in March 2016, said “rates are expected to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”. Given the strong growth and inflation numbers, we think that Draghi will be under increasing pressure from within the ECB to signal the start of rate normalisation and tapering of the ECB’s bond buying programme. Bond yields reacted to Friday’s news by spiking higher, and we expect that trend to continue for the balance of 2017. We continue to like a short duration bias in European sovereign bonds.