Hope that Britain can stay in good shape and on pleasant terms with its soon-to-be-separated European relatives.
Global bond yields have largely tracked sideways over the past week, following relatively robust US economic data. Growth in retail sales and a rebound in the Philly Fed survey suggests that growth momentum remains robust in the wake of the US / China trade agreement.
In the weeks ahead, we are inclined to look for better European data as well, though with inflation remaining benign and net eurozone government supply in negative territory in 2020, it is hard to project yields rising too far for the time being.
Healthy demand for new issues suggests that investors have cash they need to put to work and there is little evidence of heavy seasonal supply leading to any indigestion at this point.
In the US, the Democrat Primaries are just about to get underway, but it appears that President Trump is continuing to ride high in the absence of a clear popular Democrat front-runner. Arguably, the Presidential intervention in Iran could have backfired, but this now seems to have strengthened his standing.
With US stocks posting fresh record highs and volatility dropping, it appears that the macro backdrop is relatively benign for now.
Germany: growth vs green
Meetings with policymakers in Brussels this week reaffirmed the growing commitment to investment in green infrastructure.
In some cases, this may be seen as a ‘relative green’ switch in terms of moving from coal to gas and for now there seems little appetite to do anything that will sacrifice growth to meet environmental needs. However, momentum is continuing to build and whilst there is little evidence yet to support an easing in the German fiscal stance, it is widely expected that as politics evolve then greater progress will be made.
Away from the environment, there is little sense of crisis at all in the EU. It appears that Von der Leyen is very keen to execute a trade deal with the UK, reducing the risk of a fight which could end in a hard Brexit.
In the Treaty there is provision for an extension until December 2022, though it is thought that considerable progress can be made with simultaneous work across multiple fronts beginning in February. An extension itself will need to be agreed by July, but it is thought that Johnson will be able to position this as some kind of ‘political ratification period’.
In any case, the process of passing aspects of the deal through National EU Parliaments could mean that this takes an additional 12-months anyway. Broadly speaking, there is a thought that Boris wants Brexit to become forgotten about once the UK technically leaves at the end of this month.
Boris bounce gives the UK a boost
Aside from Brexit, UK markets have registered some of the largest moves in the past week, following dovish comments from the Bank of England (BoE) and then a surprisingly low print on inflation data.
Gilt yields have rallied, with interest rate futures markets now discounting more than 30 basis points of UK rate cuts in 2020, with a probability of over 50% that a monetary easing will be announced as soon as the end of this month.
We have been surprised by this, based on a view that the economy is likely to experience a growth rebound in the wake of the recent General Election.
We already appear to have seen a ‘Boris bounce’ in house prices and expect PMI surveys to show a material strengthening in UK business confidence when these are released next week. With fiscal easing being delivered, we believe that this would be a very strange time to deliver a rate cut and would question whether this will be particularly helpful or growth-supportive.
Consequently, we maintain a short position in UK Gilts and having heard nothing in Brussels to cause us to be over-concerned that Brexit headlines next month should be too disruptive. We will look for recent moves to be reversed in the next few weeks – particularly if global yields drift a little higher.
Elsewhere in Europe we have become a little bit more concerned that a deteriorating Italian political backdrop is making an early election more likely, with a near 50% probability. Expectations that this would lead to a Salvini government creates a headwind for BTPs, even if the broader environment is more generally risk supportive.
We have tended to think that the fear of a Salvini administration would probably be worse than the reality of such a government, though shorter-term volatility could mean an opportunity to add exposure at more attractive levels.
Consequently, we have closed long BTP positions looking to return to the market on weakness, as it is difficult to see political risks going away for the foreseeable future and it is hard to project much spread convergence if this is the case.
Generally speaking, we remain more constructive on Greece and continue to favour corporate credit with investors being squeezed into assets that can deliver a positive yield.
We see improving growth data putting some modest upward pressure on yields, with risk assets likely to be well supported whilst 10-year Treasuries remain below 2% yields. We are hoping to see strengthening UK numbers and that these will cause Carney to stay his hand on interest rates at his last monetary policy meeting before Bailey takes the helm at the BoE in March.
Prior to our trip to Brussels this week, we had wondered if a robust attitude towards the UK following Brexit could threaten this positive economic view. However, as per metaphors for Prince Harry and the UK Royal family, we are encouraged that there is still some love on both sides and a hope that we can remain good friends – even if separation will inevitably mean that we aren’t as close as was once the case.