Because the markets are in crisis
What is happening on the markets. The analysis by Mark Dowding, CIO of BlueBay
Over the past week, government bond yields globally continued to rise, with markets focusing on sustained outbreaks of inflation in Europe in the wake of rising food and energy prices. Wholesale gas prices in the region are now 10 times higher than last year, and this continues to be a major concern in a context of supply disruption.
While governments have tried to protect consumers and businesses from the consequences of this energy shock through subsidies and subsidies, secondary inflationary impacts are starting to manifest more broadly in the prices of goods and services. Meanwhile, the recent drought in Europe is exacerbating food inflation and fertilizer shortages highlight the risk of a further decline in food supply in the coming period.
Due to these effects, it seems likely that Eurozone inflation will only peak at the beginning of 2023, while in the UK the Consumer Price Index is set to remain in double digits for the months to come. with a possible peak around 15% in the first quarter of next year.
The compression of real incomes in Europe exacerbates the risks of recession. However, with comments from ECB Executive Board member Isabel Schnabel who said that rising interest rates have little impact on price cuts, it appears that central banks will continue to need hikes, too. if growth continues to collapse. This stagflation environment is challenging and it is understandable that governments want to cushion the blow by easing fiscal policy.
However, rising spending, at a time when government revenues are declining, threatens to drive fiscal deficits across the region in the coming quarters. Arguably, more favorable fiscal policy may mean central banks will have more room to raise rates further in due course, and it is possible to speculate that yields may continue to rise over the coming year, unless news arrives. better on the inflation front.
From this point of view, we have recently become more bearish on the outlook for the European duration. We also see a growing threat of stopping the recent risk rally, which has led to a tightening of sovereign and corporate credit spreads in the region. In Europe, we believe the stagflation dilemma continues to be more pronounced in the UK, where we maintain a structurally bearish view on gilts, UK risk assets and the pound.
We also believe that any political debate aimed at weakening the Bank of England's mandate (so as to prevent interest rates from rising too much in the short run) can only mean that interest rates will need to rise more in the long run. . As a result, we believe the UK curve should pick up, in contrast to the recent price action which has led to a flattening of the curve.
In the meantime, it is interesting to compare the prevailing dynamics in Europe with that seen across the Atlantic. Here it appears that policymakers are much more confident that inflation has peaked and is on a downward path. The moderation in oil prices, the strong dollar and the cooling of the housing market are all factors that can contribute to moderate prices in the coming months. Moreover, unlike European fiscal policy, which can help raise inflation, it is surprising how the US fiscal deficit has shrunk over the past year, thanks to the conclusion of spending programs, increased tax revenues and a robust economy. After seeing double-digit deficits (as a percentage of GDP) in 2020 and 2021, the current quarter sees the US fiscal deficit close to 3%. In this way, fiscal and monetary policy has been well coordinated in the United States over the past two years, stimulating the economy during the pandemic and, more recently, working to moderate excess demand.
From this point of view, it appears that the uniqueness of US growth is not going to end anytime soon and, fundamentally, the US economy appears to be in a much stronger position than overseas.
In Asia, Chinese growth continues to be flat, due to the crisis in the real estate market and careless zero-Covid policies. Over the past week, the Beijing authorities have increased fiscal and monetary easing, but we are not convinced that the measures taken so far will substantially improve the outlook. In other emerging market countries, the picture is more heterogeneous and reflects different dynamics in the wake of the economic composition and political measures adopted in the past.
In general, food and energy exporting countries continue to look solid, while importing countries remain very vulnerable. Orthodox policies have favored the peak of inflation in several countries and this could favor some local rate curves. However, there continue to be examples of those looking to swim against the tide, such as Turkey which, this week, decided to cut interest rates as a means of fighting hyperinflation.
From a credit point of view, our macro view leads us to favor the prospects of US companies over those of the Eurozone, and we believe that the addition of hedges in the Itraxx series, compared to the CDX, offers the possibility to increase returns Right now.
In general, we continue to look for opportunities to sell contrarian and, while technical market data suggests that a bearish consensus could act as a brake on spread widening in Europe, we find that sector and issuer positioning is particularly important to protect. the portfolio in the broadest sense.
Regarding currencies, we have been keen to reduce currency risk as we don't see many clear opportunities right now. We believe the Central European currency market is structurally overvalued and remain short on the Polish zloty and the Czech koruna. Meanwhile, while we believe US exceptionalism may help support the dollar, we think the greenback has now completed most of its move against the euro.
Looking at the future
It remains difficult to project a perspective view with too much certainty. Like the Fed and other central banks, we portfolio managers are also dependent on data. This means keeping an open mind to incoming information and not wanting to get too attached to individual operations. That said, a negative structural bias on UK gilts remains attractive to us and, more generally, we are increasingly skeptical about how much yield curves can flatten / reverse. For example, UK liquidity rates are now seen 125 basis points above 10-year Gilt yields in the first half of 2023, which may appear unrealistic for a couple of reasons. First, the price of long-term yields appears to incorporate a return to status quo forecast that prevailed for much of the decade following the global financial crisis – in our view, this may be unrealistic and other decades may represent a more pattern. probable compared to the most recent period, dominated by the narrative of secular stagnation and falling rates of return. Second, we wonder if the BoE is able to achieve its goals, as many rate hikes are expected in the next 6 months.
We also wonder if it might become attractive for the BoE to accelerate Quantitative Tightening (QT), reducing its balance sheet to tighten financial conditions, rather than raising rates and accumulating further suffering on consumers hit by a massive cost-of-living shock. Replacing the QT with a rate hike might make sense when the curves are reversed, as they currently are.
However, one wonders how long it will take for some bright mind to tell Liz Truss that if the BoE is raising cash by selling bonds from its balance sheet, then maybe the government could take it to finance some more tax cuts. That said, the government cannot be blamed for scrambling for mirrors, as the prospects look almost as bleak as what Manchester United fans are facing, just two games into the new season.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-i-mercati-sono-in-crisi/ on Sun, 21 Aug 2022 05:47:01 +0000.