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The beginning of the end for easy money?

11-06-2013 | News item | Léon Cornelissen Fed chief Bernanke’s words on tapering its quantitative easing program “within the next few meetings” put the cat among the pigeons. Bond yields rose, but does this really signal the end of easy money? 


Speed read

  • Global economy not yet on a sure footing
  • Fed tapering - are the jitters justified?
  • Further upside for equities as excess liquidity dominates
  • Abenomics – impressive first quarter growth
  • Emerging Market Debt loses some of its appeal
  • Europe - signs of stabilization, but still a long way to go
  • High Yield is our favorite fixed-income category
  • North America preferred region for equities


Not according to Robeco Chief Economist Léon Cornelissen, who thinks that “fears of imminent Fed tightening are exaggerated”. Although optimism on the US housing and labor markets is justified, weak data showing a contraction in the manufacturing sector caused what Cornelissen refers to as a ‘reality check’. He feels that the current softness in the US economy and the benign inflationary scenario mean we will not see a real change in the Fed’s easy policy any time soon.

According to Cornelissen the global economy is entering a soft patch, but “recession is unlikely”. 
 
The ‘third arrow’ of Abenomics
The Japanese economy showed what Cornelissen describes as ‘impressive’ growth in the first quarter, further borne out by more recent wage rises and an uptick in Tokyo CPI.

But the future of Abenomics hangs in the balance. The need for genuine structural reform (the third arrow) needs to be addressed. Cornelissen expects policymakers to be able to keep the yen weak and Abe to regain the upper hand over the BoJ if he wins the Upper House elections in July.

Europe – some small glimmers of hope

The pace of recession in the periphery seems to be slowing with economic activity in the region picking up a little – Spain’s Purchasing Managers Index hit a two-year high in May. UK service-sector data indicates what Cornelissen describes as ‘healthy’ growth so further easing there seems unlikely at present, giving new Bank of England chief, Carney, time to find his feet.

However, loan growth is weak and unemployment is on the rise in the region – there is pressure for further monetary easing. France also continues to underperform.

Looking forward, Cornelissen is focusing on the ECB’s asset-quality review due after the summer, which he hopes could clean up bank balance sheets and promote credit growth in the region.

BRICS – out of the limelight
The Chinese economy continues to weaken while Brazil is bucking the easing trend and tightening monetary policy to combat inflation.
 
The global macro picture in numbers

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Equities – so much liquidity seeking a ´risky´ home
According to Léon Cornelissen, “the ‘money’ factor still dominates the ‘macro factor’ when it comes to equity performance”. What he means here is that excess liquidity is continuing to find its way into the equity markets, where valuations are still attractive enough for a further re-rating of this asset class.
North America remains Robeco’s preferred region. The talk of Fed tapering boosted the performance of cyclicals, but Cornelissen feels recent rate rises are ‘overdone’ so defensives, which also have more favorable earnings revisions, may rebound.
 
Real estate volatility
Last month, interest rate sensitivity and less attractive valuation caused real estate to underperform equities. “We do not expect interest rates to be a negative factor”, says Cornelissen. But they could cause more short term volatility. The yield pickup relative to government bonds underpins our positive view.
 
“Global economic growth will be lower than trend due to structural problems”
 
Emerging market debt at the mercy of currency volatility
Cornelissen and his team have become more cautious on emerging market debt (EMD). They believe that developed market credits currently offer better perspectives. There are several reasons for this change of view. First, unrest in the markets has caused spreads on EMD to widen. But more significantly, last month a basket of emerging currencies depreciated by more than 6% against the US dollar. As lower commodity and food prices are causing inflation fears to subside, most emerging market central banks have been cutting interest rates and boosting their economies, causing their currencies to weaken.
 
More positive on High Yield than credits – still negative on government bonds
Chief economist Cornelissen is positive on credits, but favors high yield which “still offers decent absolute returns in the current low-interest-rate environment”. In the case of credits, spreads have hit a two-year low and some issues now have running yields well below their sovereign counterparts.

However, spreads on investment grade are still decent, according to Cornelissen. As we expect no change to central banks’ accommodative policy - “their fears of deflationary pressure are stronger than their worries about excess liquidity” - our outlook for government bonds remain negative.

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