The global economy and the Eurozone continue to grow strongly. Furthermore, the Eurozone is currently experiencing new impulses for greater European integration through the new government in France and the coalition between CDU/CSU and SPD in Germany. On the other hand the outcome of the elections in Italy brought a politically instable result. The ECB meeting beginning of March did not include significant news.
Following last week’s surprisingly strong employment report, the odds that the US Federal Bank will start raising its policy rate at the next FOMC-meeting in December jumped to almost 70%. Of course, 70% is still short of 100%, but most observers believe that something terrible must happen in the next four weeks to make the Fed reconsider, particularly in light of President Yellen’s statement in September that the FOMC’s thinking suggests a “call for a funds rate increase later this year”.
While the case for starting the lift-off remains a close call as Kenneth Rogoff pointed out, it has strengthened in recent weeks as US economic data have turned more positive relative to expectations, according to Citi’s economic surprise index. Most importantly, the improvement in the job market is continuing. The US economy has been adding, on average, 200,000 jobs in the non-farm sector each month in 2015.Read more
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).
Bond investors are faced with a difficult environment. Do corporate bonds offer the chance of a halfway decent yield?
Stampfl: The statement that bond investors are faced with a difficult environment is actually an erroneous one. A balanced portfolio consisting of bonds from the peripheral countries and the core countries across all sectors would have seen a very good risk-adjusted performance in the past weeks and months. Also, complementing the BB segment with corporate bonds generates a certain degree of surplus yield, which in funds like Reserve Corporate causes is used to boost the development. That is like switching from winter tyres to summer tyres in spring. It facilitates a smoother running and lower fuel consumption. Or, translating it to the case of the fund, it results in a surplus yield at lower volatility.
In Turkey, the impact of the currency fluctuations are being discussed and even an ordinary Turk on the street knows what it means for the currency to depreciate. For example, during a cab ride, you may have a very deep economic discussion with the taxi driver about the dollar and the Turkish lira. This is as a result of the crises Turks experienced in the past – unfortunately there was more than one! This in turn, has enabled Turks to have their guard up automatically to cope with the strong dollar and there is a dollar investment mechanism in every household immediately if they get a whiff of the depreciating Turkish lira. Corporates also got used to foreign currency fluctuations, but as an import and export oriented country, the depreciating lira has some negative implications on the corporates as well as economic indicators.
After quite a stable period the Turkish lira has started depreciating against the dollar since the final months of 2014 due to a combination of: i) President Recep Tayyip Erdogan’s comments regarding the Central Bank of Turkey, ii) the ECB’s quantitative easing program, iii) woes about Greece’s exit from the EU and iv) the FED’s rate hike expectations.
Since the cutting of key-lending rates to almost zero in the Eurozone did not suffice to keep the inflation expectations at their long-term target of slightly below 2%, the ECB Council decided in January to expand the central bank money supply until the accomplishment of the target was foreseeable.
The possible effect on the financial market and the economies are multi-faceted. 1) The excessively low inflation expectations increase. This will cause real interest rates (i.e. nominal interest rates minus inflation) to fall. 2) The currency (i.e. the euro) depreciates vis-à-vis other currencies. 3) A so-called asset price effect is created. The ECB buys bonds with low yields, resorting to the central bank money supply. This keeps bond yields very low (partially even negative). Given that, and because the volume of government bonds investable by the private sector shrinks, investors are pushed into asset classes with higher expected yields (bonds with long maturities, bonds with higher default risk, bonds with higher coupons in a foreign currency). This crowding-out effect supports asset prices. The net worth of the holders of these asset classes increases. 4) The willingness of banks to grant loans is supported by the very low bond yields.