BlueBay AM: The Genius?

February 25, 2022

By Mark Dowding, CIO, BlueBay Asset Management

Markets enter crisis mode as they wait to see how Putin reactions to sanctions.

The escalation of conflict in Ukraine is dominating markets and newsflow as we write.

Initially, yields in core rates markets moved materially lower, equities were down and credit spreads widened, but it is interesting that the stocks have recovered somewhat and yields have bounced back. Commodities, in particular oil, are rallying in anticipation of significant disruptions to energy and various metals that will inevitably result from ramped-up sanctions on the Russian regime. 

It is difficult to be too predictive about what comes next, but we make some simple observations: Putin’s stated intention is regime change in Kiev, the military incursion to achieve this is underway and, sadly, there will be casualties and terrible headlines as this progresses. 

We are waiting on detail regarding exactly how punitive new sanctions from the Western powers will be. As always, sanctions are a double-edged sword, impacting not only the Russian state but its trading partners and global commodity markets. Once we know more on the depth of new sanctions, the next uncertainty will be how Putin reacts.

With so much uncertainty over how and when we get to the point of a negotiated truce, ceasefire or settlement, we are refraining from being too active in portfolios until the fog of conflict clears and we have more of a read on the impact of sanctions. 

Inevitably, these types of events lead to irrationally priced assets; we always look to avoid cutting out of positions that have solid fundamentals and medium-term value. We are also constantly looking out for assets that overshoot and become mispriced.

Away from geopolitics, there have been relatively few notable data releases during the past week. However, it has been notable to observe ongoing progress towards an exit from the pandemic, with many countries continuing to ease restrictions as Omicron starts to fade. 

In England, all Covid restrictions have now been removed and it feels very much as if life is returning to normal, albeit the new normal continues to look quite different to life before the pandemic first struck. 

It appears that most employers are now offering hybrid working models, although in some sectors the numbers of those moving completely to remote working are outnumbering those who plan to return on a full-time basis. 

Meanwhile, labour participation remains sluggish. In part, this may have resulted from individuals reassessing their life priorities and deciding to step away from work. Labour markets could remain very tight if this pattern is slow to correct itself.

Looking ahead

If we put the situation in Ukraine to one side, it feels like March will be an interesting month with central banks being watched for their delivery in the wake of recent more hawkish signals. 

We continue to think that the Fed will raise rates by 25bp and signal more rapid balance sheet reduction in favour of a bigger 50bp move. 

A similar message may also come from the BoE – hiking at a third successive meeting with more to come in the months ahead. 

Meanwhile, we think that the ECB will raise its economic forecasts, end asset purchases in September and signal higher rates later this year. However, all of this could be shaped by incoming economic data around inflation and wages and will also be subject to how events in Ukraine play out.

Intrinsically speaking, we think that it will be difficult for yields to rally much further, even if we see a continued risk-off move in markets. However, with uncertainty elevated and material rate hikes priced into central bank trajectories for 2022, we think that there is no need to take an assertive directional stance for the moment. Instead, we will be looking for the clouds to clear in the weeks to come. 

Ultimately, we remain constructive on growth and look for inflation to remain higher than others are expecting. Consequently, we have a bias to be short with respect to rates but hope for better entry points in the days to come.

In the meantime, from a human perspective, we hope for a speedy resolution to the conflict in Ukraine. Unfortunately, it does feel we have turned the corner into a much more dangerous and uncertain world.