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Macro matters: markets absorb contrasting news which drives fresh bond yield spike

The net effect of this confluence of variables, has led to a rise in core bond yields, explains Amundi.

Pascal Blanqué, Group Chief Investment Officer at Amundi, explains:

“Last year the key drivers of markets were inflation expectations and interest rates. Now, the main factors causing market movements are expectations of recession and policy actions (monetary and fiscal). On both, we believe the markets expect too much. In our central scenario we do not think an economic recession will occur in next 12 months as domestic consumption remains strong (although manufacturing is weak). However, corporate earnings may still be impacted, which is a fragile environment for equities.

“In addition, in our view, markets are too optimistic with regards to their expectations of policy measures. The ECB seems to have exceeded investor expectations by implementing easing measures. However, it is clear, that monetary policy has to go along with fiscal measures (the former alone is not sufficient to counteract low growth and low inflation). Regarding fiscal boost, we expect some fine tuning but not a substantial change in EU fiscal rules. When expectations on policy actions are high, the risk for investors to be disappointed is also high, causing volatility in most markets.

“Having said that, there are other two alternative scenarios that could play out in the future. The more negative one is that the slowdown is more pronounced than expected due to the ongoing trade war. This could affect capital expenditures or may even cause employee dismissals, particularly in the US where labour laws are flexible (however, in the short-term, businesses are reluctant to reduce staff as its expensive to replace workers), thereby affecting ‘robust’ consumption.

“Fear of recessionary risks could also lead to a recession, which could be directly negative for risk assets. There is also a third possibility – central banks implement aggressive policies and fiscal measures are used as well. This would further support risky assets. On the basis of these scenarios and the fact that we consider the first and the second the most likely ones at the moment (fragilities, with high valuations in many areas of the market and risks of disappointment), we believe that investors should remain cautious and agile.

Amundi outlines its four convictions…

(1) Interest rates will stay low leading to a continued hunt for yield among investors, given that economic growth is likely to remain subdued.

(2) Trade and politics will remain in focus with less globalisation ahead. Therefore, the importance of domestic consumption and related services in individual countries across the emerging and the developed world would increase.

(3) In equities, focus on fundamentals and earnings will be back.

(4) Liquidity remains crucial for investors as they should be aware of the trade-off between risk, return and liquidity that must be taken into account.

Blanqué added:

“Our main message for investors is to try to preserve capital in this highly uncertain scenario and be agile in looking for opportunities amid volatility. Going forward, investors will have to assess the evolving probabilities of the different scenarios. Today, our base case of the markets expecting too much on the policy mix is the most likely. There are excessive fears of a recession and also the marginal effectiveness of monetary measures is diminishing. In addition, we believe there are political and economic limitations which would prevent a fiscal u-turn in Europe/Germany.”

james.wallace@realassetmedia.com