BlueBay AM: The devil is in the details

26 jul 2019

By Mark Dowding, CIO at BlueBay Asset Management

ECB promises more monetary easing but the lack of detail leaves investors disappointed.

It’s been a relatively quiet week with summer holidays and important central bank meetings – the ECB on Thursday and the Fed next Wednesday – dampening volatility somewhat.

Data has been bifurcated. US economic activity has, on balance, been stronger than expected, but Europe, and especially Germany, continues to experience softer numbers.

US yields have moved sideways over the past week, but German Bunds and UK Gilt yields moved modestly lower on the dovish ECB meeting and weaker economic data. Sovereign credit spreads have continued to compress.

European stimulus

The ECB meeting was the big event of the week, and despite our slight fear that Draghi overreached in his speech in Sintra, economic data has been weak enough to bring the Governing Council on board to promise a significant package of additional monetary easing in the eurozone in September. However, the lack of delivery or further details will probably prove a small disappointment.

The package will include a cut in interest rates, some form of tiering to mitigate bank stress and the reopening of the asset-purchase programme.

Details of the package will only be released at the meeting in September, and although the direction of travel is clear, we continue to wonder if the market has gotten a little over its skis in terms of the expectation of what is to come.

The one other thing worth noting is that the ECB may be more split on what to do than many realise, and this could see some interesting headlines in the coming weeks.

Patiently awaiting Fed updates

In the US, Fed members are currently in a ‘blackout’ period before the FOMC meeting next week but this hasn’t detracted from news and speculation regarding what to expect.

We wouldn’t be surprised if the Fed meeting disappoints some overly bullish projections and so we could see a case for consolidation in the global risk rally or a potential reversal in August – particularly if there is a risk-off catalyst, such as a negative trade headline.

All change in the UK!

It’s been a big (and sweltering!) week in the UK, where Boris Johnson has been officially coronated as the new prime minister and immediately fired most of the existing cabinet, replacing many Remainer-oriented ministers with hard-core Brexiteers.

Parliament will be in recess for the next six weeks so there is likely to be something of a lull.

However, we expect volatility to pick-up in the autumn when the party conferences get underway and the ungovernability of both the Tory Party and Parliament as a whole comes home to the excitable new PM.

At the end of the day, the composition of parliament remains unchanged and uncertainty over the 31 October Brexit deadline means the risk of an imminent election is high.

After the notable move in sterling, we have become less convinced on the asymmetry of being short and hence have realised gains on this position.

On UK rates, we maintain our conviction in short Gilts and still see valuations at this level as misstated.

Banks lead US earnings round-up

The US corporate earnings season has continued to rev-up over the past week, with results generally showing better-than-expected EPS growth versus depressed consensus estimates.

US bank results confirmed the strength of the underlying economy and continued to evidence solid credit fundamentals despite cuts to net interest income outlooks due to the lower interest-rate environment, which remains more of an equity story.

In terms of negatives, weak earnings and guidance from the industrial sector continue to highlight the challenges within the space and offer growing evidence of a deepening slowdown in global manufacturing.

Caterpillar, seen somewhat as a global macro bellwether, trimmed back profit forecasts citing weaker sales in China and higher tariff and labour costs, providing ammunition to the bears that the world economy continues to slow as trade tensions take a toll on commerce and sentiment.

We continue to believe that this theme of increasing sector and single-name dispersion will remain high, driven by factors such as regional divergences in growth, M&A, tariffs and shifting monetary policy.

Looking ahead

The next big event is the Fed meeting next Wednesday. Although we continue to believe the market is too bullish on what the Fed can deliver, for this meeting in particular, we are not expecting fireworks.

This should leave markets fairly becalmed through the balance of the summer. We say should, because with the cast of political leadership we now have on show, anything can happen!