The longest eleventh hour in recent history is drawing to a close. However, while the negotiations earlier this week seem to have narrowed the gap between Greece and its creditors, a final deal has not emerged yet.
Summary: The economic recovery in the developed economies is supported by the very expansive monetary policies, lower austerity pressure on the government front and among banks, and the fallen oil price. Growth rates remain moderate. In the emerging markets we can see signs of low-level stabilisation at best. The possible default of Greece, excessive interest rate hikes in the USA, a further decline of productivity, and continued economic weakening in the emerging markets are the main risks the markets are faced with.
Eurozone government bonds have ensured very good performance returns in the past years. The asset class has benefited from the zero interest rate policy and the very expansive monetary policy of the European Central Bank.
In recent weeks the prices of bonds from Eurozone countries have gone through a correction, above all German government bonds. The reasons for the specific timing of the correction are numerous and cannot easily be pinned down. In spite of slight improvements, we do not expect an interest rate reversal for the Eurozone at this point in time. The fundamentals for such a scenario are not in place.
Euro government bonds are an important component of a portfolio. From both risk and return considerations, a diversification across a broad spectrum of assets makes sense (e.g. by adding high-yield bonds, emerging markets bonds or equities).
The upcoming parliamentary elections on Sunday in Turkey could force Erdogan to postpone his plan for a new constitution and could lead to new political leaders in the Ministry of Finance and the Ministry of Economics. This would trigger an increase in uncertainty and consequently a higher degree of volatility for the Turkish Lira and the Istanbul stock Exchange.
Real global economic growth was weak in Q1. Estimates put economic growth at an annualised 1.5% (q/q). Thus the long-term trend of downward revisions is intact, which keeps the fears of global economy possibly heading for persistent stagnation alive.
The big trends of the past weeks such as the appreciation of the US dollar, the weakening oil price, falling yields, and the outperformance of Eurozone equities have reversed in the past days and weeks, in some cases drastically so.
What is behind all of this?
When both demand (i.e. economic growth) and supply (i.e. production growth) are weak and the central bank policies are very loose, we have a textbook example of an environment causing yields to fall and/or remain low. Indeed, yields were high after the Great Depression in 2008/2009. Having transitioned to a slow, weak, and fragile recovery, yields have started to fall and bond prices have started to rise (i.e. asset price inflation). Even if the economic regime remains unchanged, the market environment may change; the higher the asset price, the lower the expected return or yield.
Real global economic growth was surprisingly weak in Q1. The preliminary estimate for the annualised growth rate of Q4 2014 to Q1 2015 is only 1.5%. This is mainly due to disappointingly weak growth of the GDP in the USA (+0.2%), in China (+5.3%), in the UK (+1.2%), and in Japan (+1.5%; estimate). Brazil (-2.4%) and Russia (-11.5%) have even shrunk (both figures are preliminary estimates). In line with this situation, the data surprises have been largely negative, and the trend of downward revisions for economic growth has continued.
The new normal
The importance of China for the global economic and financial system continues to grow at a rapid pace. Last year the country set a new milestone by becoming the world’s biggest economy. The total value of goods and services produced in a year exceeds that of the United States. Thus, at 30% China accounts for the largest contribution to global economic growth.
The dynamics of the economy and the markets have declined. Global economic growth is down on a quarter-on-quarter basis, the two most important trends of the past months (appreciation of the US dollar and falling oil price) have come to a halt, inflation is not falling anymore, and the US Fed has put a damper on the expectations of interest hikes. One important exception: the Eurozone has been picking up speed.
The most important central bank in the world, i.e. the US Fed, made an announcement yesterday that attracted a large deal of attention from investors. The bank withdrew its assurance to remain “patient” before the Fed funds rate would be increased. This paved the way for a possible abandonment of the zero interest rate policy, if economic need be. The new formula goes like this: the Fed funds rate will be raised once the labour market has improved more and the FOMC is optimistic about inflation rising towards the medium-term target of two percent.