3 Things the European Investment Grade Fixed Income Team Talked About Last Week

1. Eurobonds – Myth or Reality?

The whole topic of Eurobonds has gradually been appearing on the investment horizon in Europe again, having been discretely consigned to the basement for some time now. The concept is probably familiar to many – deeper economic and fiscal integration is needed in Europe, and the idea of debt mutualisation is central to proposals for deeper fiscal integration. But there has always been a big problem – it is seen as political suicide in Germany to campaign for common “Eurobonds”, given that many German voters see the idea simply as a wealth transfer from the austere North to the profligate South. French President Emmanuel Macron first floated the idea of Eurobonds during his recent campaign, but cleverly tied it to new debt that would be backed by a Euro-area tax base and be used to finance infrastructure investment and joint EU defence procurement programmes. Then a recent EU Commission paper on the future of the Euro suggested the creation of sovereign bond-backed securities (or Euro Safe Bonds, known as ESBies). These securities would package together the national debt of the Euro countries into a new asset, which would have the same risk weighting as existing sovereign debt in the EU. Unlike the U.S., which has U.S. Treasuries, Europe has no form of collective debt instrument, which means that European banks tend to be heavily invested in their own national debt. That leads to a situation where concerns about the creditworthiness of the sovereign impact on the bank’s creditworthiness, so ESBies could be a neat way around this problem. Predictably, the German reaction was “Nein, danke”, and a reminder that “Member States must live up to their responsibility to create stability and growth in the Eurozone through structural reforms and debt reduction”. In other words, there’s no chance that Germany will lend its creditworthiness to support the rest of the Eurozone. But maybe it’s not so black and white. These are first proposals, and could be re-worked into something more acceptable. Should Mrs Merkel be re-elected in September, she, along with Macron, will form a strong force for further European integration. Part of that plan might just involve some form of debt mutualisation in return for deeper fiscal integration.

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The Fed: Making Good on its Goal of Normalizing Rates

Ken Taubes is Chief Investment Officer, US.

The Tug of War Between the Markets and the Fed Continues: Will the Fed Prevail this Time?

With the path of future rate hikes, the tapering of the Federal Reserve’s (Fed’s) balance sheet, growth and inflation, views all in play, the Federal Open Market Committee’s (FOMC’s) June 13-14 meeting represented a key event for markets; the Fed did not disappoint. As expected, they voted 8-1 to move forward with a 0.25% rate increase, despite recent softening in inflation and first-quarter US GDP growth. But, their outlook for the future was more hawkish than expected, and at odds with what the market has priced in, especially on the heels of May’s lower CPI report. Continue reading

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The Lake Wobegon Daze

Lake Wobegon is a fictional town created by American writer Garrison Keillor. It is a place  where “all the women are strong, all the men are good looking, and all the children are above average”.  The term has come to associate with an American pastoral Eden, particularly in the lake culture of the northern Midwest. As the Northern Hemisphere heads into peak summer, we are reminded of lazy days by lakes and seashore. Could it get any better? Maybe not. It’s time to start packing the bags.   Continue reading

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3 Things the European Investment Grade Fixed Income Team Talked About Last Week

1. UK Election – Dis-May in the UK

Well, that didn’t go to plan, did it? Football pundit Gary Lineker said that UK Prime Minister Theresa May “had won own goal of the season”, whilst ex-Chancellor of the Exchequer (and now editor of the London Evening Standard) took the chance to take a swipe at May by saying that the Conservative government were “in office but not in power”. There really is so much to discuss but not enough time or space, so let’s concentrate on the key points. The result throws the UK’s Brexit strategy into disarray – May went to the country seeking a mandate to negotiate the UK’s exit from the EU, but failed to get that mandate. Brexit negotiations were meant to start shortly, but may now be postponed amidst Conservative turmoil. But what won’t be postponed is the Brexit clock – Article 50 has been triggered and the UK will leave the EU in March 2019. Make no mistake – Article 50 is a legal process, not a political process, and there will be no concessions from the EU because of what the Financial Times calls a “self-inflicted political problem”. Now we also have uncertainty – will Theresa May even survive as Prime Minister for the next two years? How soon before new elections – we know that minority governments tend to have a short lifespan. With no mandate for a hard Brexit, will the Conservatives stance change to a softer (perhaps more realistic) stance? We believe the consequences are either an increased possibility of a no-deal outcome or the acceptance of an EU-driven agreement. Another strong message from voters was pushback against austerity, so expect the new Conservative coalition government to abandon their manifesto plans to continue fiscal consolidation, and instead to loosen the budgetary purse-strings considerably. Political uncertainty also tends to dampen sentiment and confidence, so that could exacerbate the recent weakness seen in the UK economy. All in all, it probably means the Bank of England will leave monetary policy unchanged for the foreseeable future, at least well into 2018. UK bond yields may get some support from concerns about slowing economic activity, but are likely to underperform other bond markets on increased political concerns. As mentioned in our blog a few weeks ago, we anticipated some devaluation in Sterling. From here it’s difficult to call Sterling’s path, given all the uncertainty, but we would probably remain underweight, particularly against the Euro.

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The Unexpected is Back

The unexpected has again been the outcome of the U.K. election: the Tories have lost their Parliamentary majority, while the Labour Party has substantially increased its position. This result triggers a new period of political instability, with Prime Minister (PM) Theresa May’s position being substantially weakened and increased uncertainty likely to have an impact on Brexit negotiations. Continue reading

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