Dieser Inhalt ist für professionelle Anleger im Sinne der MiFID-Richtlinie bestimmt.
By Gilles SEURAT, Fixed Income and Cross Asset Fund Manager, La Française AM
For investors, 2022 began on a very bitter note with most asset classes in the red. Equities suffered, with European indexes at -10%. The only equity sectors that have stayed afloat are basic resources and energy, which have both benefited from the drastic rise in commodity prices.
However, the biggest loser is the fixed income market which continues to suffer due to rising core bond yields (German 10y bund +76bps, 10y US Treasury Note +96bps) and widening spreads (Euro Investment Grade +42bps, Euro High Yield +92bps, Italian BTPS +17bps, Emerging Market debt + 9bps, etc.). Consequently, the Euro Aggregate index is -5.42% YTD. For equity investors who are used to double-digit drawdowns, these losses might seem contained. But for fixed income investors, 2022 marks the worst year ever. (Source: Bloomberg, as at 25/03/2022)
The two culprits of the poor performance of fixed income markets are Vladimir Putin, whose war in Ukraine has sunk investor sentiment, and central banks, namely the Federal Reserve (Fed) and the European Central Bank (ECB) which have adopted a hawkish path in their war against inflation. Concerns associated with the Russia/Ukraine war have soured investor sentiment as markets anticipate downward growth revisions and that investment projects will be put on hold. We can already witness the negative impacts on consumer loan demand as well as on homebuyer activity in France.
The primary objective of central bank policy has and will continue to be price stability. To some extent however, the Fed is an exception as it has an implicit dual mandate which includes maintaining a low unemployment rate. Nevertheless, this second objective is clearly secondary relative to price stability. Though the ECB and Fed do not have the same tolerance regarding price pressures, both take action when the organizations deemed necessary, even vigorous action, i.e. Fed Paul Volcker in the early 1980s or ECB Jean-Claude Trichet in the 2000s.
However, over the past ten years, inflation has been very low and central banks have had no reason to implement restrictive measures. Quite the contrary! There was heavy political pressure to ease monetary policy. Remember former President Trump’s demands for rate cuts back in 2019.
But now, with inflation soaring to a 40-year high, political pressure has shifted dramatically. Governments have declared inflation the worst of evils, and central banks are weary of not tightening monetary policy enough. Therefore, central banks are rushing to exit quantitative easing programs and to begin a hiking cycle that should have begun sooner. For benchmark purposes, the Taylor rule prescribes a current value for the Federal funds rate of around 10%, the highest estimate since the 1980s and far from today’s value! Keep in mind that the Taylor rule considers economic fundamentals, such as the unemployment rate and core inflation, which today are at historical extremes. The same tool (Taylor rule) can be used for the Eurozone, in which case the forecasted interest rate is 7%. All in all, the path of least resistance remains higher rates.
Unfortunately, the war in Ukraine has accelerated the macro trend of higher inflation. As a matter of fact, Russia is a major oil exporter (10% of world production, Reuters), and the war has sent prices through the roof. The same can be said for many other commodities such as wheat, for which both Ukraine and Russia are major producers (respectively, 8% and 18% of world exports, source UN Comtrade). The war is forecasted to slow growth in Europe by 1.4% and in OECD member countries by 1%, not material enough to warrant a policy U-turn.
Against this backdrop, central bank actions are an obstacle for battered financial markets rather than a support.
For investors, the well-known “Fed Put”, which refers to Federal Reserve easing policy when fears of recession send equity markets south – is no longer a real possibility; or at least not until markets start pricing a strong decrease in demand with a recession, in which case, the “Fed Put” strike price would be much lower.
How does this context bode for financial markets? What does it mean for asset performance in the coming months? We believe markets will continue to price a significant number of hikes during the next twelve months. That being said, we do not expect the long end of the yield curve to increase significantly as long-term trends continue to prevail: high debt, low population growth and digitalization have a negative impact on long-term nominal growth and hence long-term yields. This explains why yield curves should continue to flatten in the developed world. In terms of regions, we consider Eurozone bond yields to be more vulnerable to an increase in interest rates than US bond yields. Indeed, Eurozone inflation is more sensitive to Russia because of its dependance on the Russian natural gas supply. Therefore, inflation upside surprises are more plausible than in the US. If, as we expect, yields rise more in the Eurozone than in the US, the Euro should appreciate against the dollar. Moreover, investor sentiment on the Euro is very pessimistic so the unwinding of short positions should help the parity to rise as well.
Disclaimer
This commentary is intended for non-professional investors within the meaning of MiFID II. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. It may not constitute investment advice or an offer, invitation or recommendation to invest in particular investments or to adopt any investment strategy. Past performance is not indicative of future performance. The opinions expressed by La Française Group are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Published by La Française AM Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, a subsidiary of La Française. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997.