Crucially, the ECB’s forward guidance is now open-ended and state-contingent, as they plan to keep rates at present or lower levels until inflation robustly converges towards the target, with QE similarly to continue until shortly before the first rate increase. With a lack of inflationary pressures within the region as well as globally, any hawkish shift is therefore unlikely in the near term. We therefore see asset purchases continuing for the foreseeable future, which should provide a backstop for core government yields as well as peripheral spreads, keeping them supported.
If anything, risks still appear to be to the downside for growth globally given the uncertainty that the US–China trade war has resulted in. We thus also think that US government bonds can hold onto gains, especially given the current market pricing where investors are anticipating an easing cycle that is closer to Powell’s “mid-cycle adjustment”, with two rate cuts priced in over the next year. If we do see further growth weakness materialise or geopolitical uncertainties rise, then this may force the Fed to cut interest rates more than anticipated, which makes longs at the front-end of the US rates curve an attractive proposition right now.
For credit markets, we see much of the monetary stimulus described as largely priced into valuations, whilst uncertainty surrounding trade, Brexit and global growth still weighs on the outlook and leaves us cautious in our exposure. Although the ECB did deliver with QE, it was clear to see that the Governing Council was looking to pass on the baton of future stimulus to fiscal authorities, given the lack of unanimity on the QE decision. Similarly at the Fed, the latest dot plot highlighted a split board with regard to the need for further rate cuts this year. Therefore we find it hard to rely on more monetary stimulus to fuel further spread-tightening, given that central bankers may become more reactive than proactive in light of these differing opinions between board members. Bearing this in mind, we will be focussing on the global growth data, looking out for signs of stabilisation in the manufacturing sector, as well the upcoming US–China trade talks, as markets hope for a breakthrough in negotiations.
Portfolio Manager, Macro Strategist