BlueBay AM: Bears get back in your box

April 5, 2019

The second quarter started off on a solid footing, with global risk assets and core yields trending higher as robust economic data and further optimism over a US-China trade deal helped to alleviate lingering global growth concerns.

Upbeat China insights

Slowing activity in China has been viewed as a principal downside risk in recent months. However, markets breathed a sigh of relief following the March Chinese manufacturing PMI numbers as they surprised to the upside, demonstrating a pick-up in activity across the board (most notably in small and medium-sized businesses).

While it will take more data points to see whether China has indeed turned a corner, the early signs of recovery seem to suggest the government’s fiscal stimulus and monetary easing have kicked in and are providing support to the struggling private sector.

Speaking to those on the ground during our recent trip to China has also led us to conclude that the transmission mechanism from policy easing to real economy is becoming effective and should become increasingly more so with the removal of bottlenecks within the local governments and banks over the months to come.

Greece and Italy hold European promise

In the eurozone, we witnessed evidence of green shoots over the past week with a stronger set of numbers in services PMIs and retail sales.

Italian services PMIs also came in meaningfully stronger versus expectations, jumping to 53.1.

While eurozone manufacturing activity remained sluggish, we are starting to see the rebound in the eurozone economy that we have been looking for. For this reason, we remain bullish on European debt, particularly Italian and Greek government bonds.

US risk chatter misplaced

Our constructive outlook for the US economy was also validated by much stronger ISM manufacturing numbers, showing positive readings in new orders and employment.

We strongly believe that talk of US recession risk is misplaced as consumer spending remains strong. We maintain our view that the underlying strength in the US economy will lead the Federal Reserve to change tact and resume its hiking cycle by the end of the year and into 2020. As such, we remain short US duration given its compelling asymmetry.

Soundbites over the week clearly show that US-China trade discussions are improving, with officials signalling an end could be near after much negotiation. With trade envoys busy travelling between Washington and Beijing, solid progress has been made on key issues and a grand finale at Mar-A-Lago looks increasingly within grasp.

US and China are finalising details around enforcement mechanisms, IP protection and by how much tariffs are to be rolled back. Granted, the stakes are high for both sides and the situation is still fluid, but we see a possible resolution to break the impasse in the next few months, with Trump likely using it as a political win into the next presidential election race.

Cross-party conundrum for the UK

While we are seeing green shoots elsewhere, Brexit worries still weigh heavily on the UK economy. UK services PMI showed a sharp dip into contractionary territory for the first time since July 2016. Manufacturing PMI saw a temporary boost as companies ramped up production amid fears of a no-deal Brexit; the stock-piling sub-index surged to new highs before the original deadline, but the tailwind is likely to be short-lived.

Amid all the political noise in Westminster this week, Theresa May sought a further delay to Britain’s exit from the EU and aim to forge a cross-party tie with Corbyn on a joint-plan.

However, we still believe that a long extension on Brexit is more likely than a quick resolution, and a general election is more likely than a second referendum to break the current deadlock. If May were to endorse a softer Brexit via backing a customs union or the single market, she would risk splitting her own party.

We are still sceptical that May and Corbyn can unite before next Wednesday’s emergency EU meeting. If talks with Labour fall apart, alternative options would be put forth again for parliamentary voting.

However, after repeated failures to hash out a unified position, the political situation remains messy and we do not see May on the cusp of a victory.

In our view, UK assets are still under-pricing the risk of a no-deal outcome and a Labour government.

Looking ahead

Overall, we remain upbeat on the global macro backdrop, a view which has been confirmed by recent data across the major economies. The positive confluence of steady growth, dovish central banks and very low core yields should continue to drive a grab for yield.

Notwithstanding bouts of volatility, positive tailwinds from a US-China trade deal, coupled with stimulatory central bank impulses, should further support risk assets.

With equity markets notching up solid year-to-date gains, even Bitcoin joined the party making a comeback with a 20% rally this week alone. For now, the growth bears should crawl back in their box as the worst seems to be behind us.