The economy’s v-shaped recovery has been taking root in recent months, despite lingering pandemic-related concerns, and companies and equity markets are booming. Yet central banks are remaining cautious and keeping bond markets on their toes with their accommodative policies. L’Agefi spoke to UBP’s Head of Global and Absolute Return Fixed Income, Philippe Gräub, to find out his view of the current climate and his forecasts. With his team of 12 divided between Geneva and London, he manages 16 of the 44 billion francs under management at UBP’s Asset Management division.
How do you see the still-uncertain macroeconomic situation?
The economy will get back to its pre-pandemic levels around Q3 21 and the contrast with the dozen or so years it took to bounce back from 2008’s financial crisis is striking. Nonetheless, central banks aren’t going to give up their accommodative policies any time soon. While firms are publishing excellent results, the need for monetary stimulus is justified, especially in view of unemployment levels, which remain high. Central bankers are starting to open the door to tighter policies, but interest rates are nonetheless still very low, and the recovery that’s under way in risky assets is not, for the moment, being reflected by rates.
The question in the short term is knowing when central bankers are going to withdraw their stimulus packages. The US Federal Reserve (the Fed) is the most important one to watch, as it’s ahead of the curve; it will play a leading role for all fixed-income markets, especially those in developed countries.
The Fed has started to adapt its message by alluding – very cautiously – to reductions in short-term asset purchases, so that the door to rate rises can be opened. In real terms, what are we to expect?
The Fed has a very clear regulatory function as regards its inflation and employment mandates, which makes reading the situation easier. The US central bank views the uptick in inflation as transitory, especially given the effects resulting from the pandemic, such as the rise in the price of used cars, which are contributing to its caution. That said, it’s closer to fulfilling its employment target.
The argument for reducing its interventions will be boosted by the fear that the health crisis will leave permanent scars. In particular, the Fed is concerned about long-term unemployment, as it’s well known that it becomes increasingly difficult to return to the labour market the longer you’re unemployed. It shouldn’t be forgotten that the economy has, for a long time now, been running on weaker structural growth and inflation, as well as reduced productivity gains. This all means that we find ourselves in an environment that looks difficult to get out of.
In any case, asset-buying programmes will slow in 2022, or even from December this year, which is something that was widely pre-announced and has already been priced in by the markets. Key rates could rise gradually from the second half of 2022, creating an environment that’s highly favourable to risky assets and consequently to credit risks.
And what about the European Union (EU) and Switzerland, where the economic situation is different?
What’s certain is that the rate differential between Europe and the United States will persist. The situation in Europe is quite particular, with inflation and potential growth both being much weaker. The first step for the European Central Bank (ECB) will be to scale back its asset-purchase programmes, but that’s still a long way off. On top of that, it mustn’t be forgotten that there isn’t strong enough political unity in the EU and that the central bank is a sort of substitute for governments when it comes to reacting to crises. As for the Swiss National Bank (SNB), the context is different yet again, with attention focussed on the Swiss franc. In any case, the SNB won’t raise its rates before the ECB does.
Signs of persistent inflation may make a big difference, which is not at all visible at the moment. This is especially true for macroeconomic reasons: deflationary pressures remain significant, and then there’s the pressure stemming from the technological revolution, globalisation and demographic changes in developed countries. These factors, such as those related to new technologies, have perhaps even been exacerbated by the pandemic.
Carry strategies in particular are standing out, while default rates are low.
How is this backdrop influencing bond portfolio construction?
Carry strategies in particular are standing out, while default rates are low. The corporate debt market is attractive, both in terms of investment-grade and high-yield bonds (editor’s note: the former category offers safer returns, but ones which are lower than the latter). The banking sector’s performance also has to be mentioned, as this has seen a paradigm shift: after having been regarded as the source of the problem during the financial crisis, this time it has been part of the solution. During the pandemic, we’ve seen a change in what the regulators are saying about banks. With brilliant results and sound balance sheets, it’s a very attractive asset class for fixed income, in particular the subordinated debt segment.
Beyond being in fashion, what makes “green” bonds attractive?
These bonds are the most direct and transparent way to invest sustainably. “Green” bonds enable you to finance a real project with visibility on the changes that are being made thanks to the funds that have been made available. In our case, we analyse not only the project, but also its compatibility with the issuing company’s ambitions to transition to sustainability. “Green” debt also enables pension funds to broaden their investment horizons, as it’s better able to satisfy certain strict sustainable financing criteria.
It’s still hard to estimate the influence that sustainable finance will have on portfolios. It’s a movement which, in the first instance, is demand-driven and has been accelerated by EU regulation, which requires all funds with a European passport to set out their sustainable investment approaches. In the final analysis, everything depends on the clients. Not offering enough ESG solutions could mean being ruled out, but the effect of being “fashionable” makes identifying needs more complex. Whatever the case, we’re ready.
What can we expect from the fixed-income market in the longer term?
You have to keep in mind that regulators’ demands for banks to increase their minimum capital requirements has reduced market liquidity, which also means that market-moving events will have a greater impact when they hit. And regulators won’t let up the pressure in the next decade; the 2008 crisis will stick in people’s minds.
Central banks’ unorthodox tools will also continue to be used in the long term, which is to say for as long as the low growth and inflation environment is set to persist. That said, the health crisis has influenced forward guidance given its very different nature from the 2008 financial crisis. If you take the example of Janet Yellen and then Jerome Powell, as a consequence of an emergence from the crisis which has been spread out over a long period, we’ve moved on from calendar-based growth to growth linked to targets, given the V-shaped recovery coupled with an uncertain environment.
On a different note, exchange-traded funds continue to generate pressure on margins. Nonetheless, bondholders are less affected by this conflict between passive and active management. Given the fact that it’s inherently less liquid, the market is much more difficult to replicate efficiently.
Philippe Gräub
Head of Global & Absolute Return Fixed income
View his Linkedin profile