BlueBay: Getting ready for the summer macrowave!

BlueBay: Getting ready for the summer macrowave!

Outlook
Outlook vooruitzicht (11) silver lining herstel

By Mark Dowding, CIO at BlueBay Asset Management

With various macro events on the horizon, markets should be wary of taking a siesta in the sun.

Markets were relatively calm in a shortened week here in London. Government bond yields were little changed, the US dollar was stable and volatility remained subdued across most asset classes.

The 10-year US Treasury yield has been trading in a tight range in recent weeks, and it seems macro investors are happy to sit back and enjoy the sunshine while they can. But as we enter June, we believe there are plenty of macro events to look forward to that could potentially jolt markets – beginning with the much-anticipated US jobs report later today.

Beige Book

Notwithstanding last month’s disappointing report, we continue to articulate the strength of the US labour market based on positive secondary and survey data, and believe this will eventually translate into robust job additions over the coming months.

In that respect, it was also interesting to observe the latest findings from the Federal Reserve’s (Fed) Beige Book, which largely confirmed earlier anecdotes that labour shortages are rife across the US, with nearly all districts represented in the report noting difficulty in hiring new workers.

At a time when US job vacancies are also rising, such reports are somewhat at odds with the headline payrolls reading. It seems that ongoing unemployment benefits have been something of a disincentive to work, but as these start to dry up – as is the case in a number of states – we remain confident that the economy should be back around full employment by the end of this year.

With the Beige Book also highlighting rising labour and other input costs at a time of rising demand in the economy, the pass-through to consumers has been more palatable. Consequently, we think that inflation may go up again this month and may be slow to come back below 3% in the months ahead.

Central banks

On the central bank front, speakers continue to shift towards a more balanced view of their respective economies as they reopen and vaccinations accelerate.

In the US, Fed governor Lael Brainard noted in a speech that while it is also important to be attentive to the risks of pulling back (monetary support) too soon, it is also important to be attentive to upside risks. This is a slight shift in rhetoric, which we believe will likely become commonplace should data points continue to hold form.

In the UK, Bank of England (BoE) policymaker Gertjan Vlieghe sounded a hawkish tone by communicating that, if the labour market proved stronger than expected later this year, the BoE might need to move sooner in raising interest rates. The strength of the UK housing market, fuelled by low interest rates and stamp duty holidays, is also raising a few eyebrows in the BoE regarding financial stability risks.

Finally, the Reserve Bank of New Zealand also delivered a hawkish surprise by forecasting a rate hike as early as mid-2022.

Meanwhile, the European Central Bank (ECB) meets next Thursday, where controlling the narrative around the ‘tapering’ of quantitiave-easing (QE) purchases will be the focus for markets, given the improved outlook since March.

As QE purchases tend to fall during the summer, we believe using seasonality as a way of keeping the current communication while reducing actual purchases until the autumn is one route the ECB could take to satisfy any market ‘taper’ concerns.

Europe’s recovery is still far from complete (only this week was the recovery fund money signed off) and any talk of tightening monetary conditions seems premature for now. However, we believe there will come a point later this year when the ‘emergency’ period of the crisis is behind us and the ECB considers how it wants to dovetail its pandemic emergency purchase programme with its more conventional tools.

UK

Closer to home, sterling has had a good run so far this year, trading almost 4% higher versus both the euro and US dollar as data and policy continues to support inflows.

However, it seems as if a lot of optimism has been built in in the short term, with the trade-weighted sterling sitting at the top of the post-2016 range. We feel this makes the cross more vulnerable to a fundamental or political catalyst.

We remain neutral on sterling for now; however, fading conventional wisdom in the UK over the past years has been a successful strategy, as prices have swung between peak optimism and peak distress.

Credit

Turning to corporate credit, it was more of the same, with spreads continuing to track sideways. Indeed, according to Bank of America index data, European corporates have traded at a spread of 85bps +/-1bp since mid-April.

Issuance has been elevated ahead of the summer lull, but the stability of spreads shows the constructive demand backdrop, with continuing inflows, solid offshore demand and ongoing central-bank buying validating current valuations.

While we acknowledge generic valuations screen tight, we still see bottom-up alpha opportunities and are focused on risk-taking in more idiosyncratic pro-cyclical issuers and subordinated parts of the capital structure. We feel these all stand to benefit from the broader reopening narrative and a chronic need for yield.

Looking ahead

Looking forward, debate among policymakers is slowly shifting towards how fast stimulus measures can be withdrawn as economies reopen and then to how different the post-Covid economy will be. Everyone, including central bankers, is watching the data for direction.

We take the view that growth and employment data in the US will remain solid and inflation will continue to surprise to the upside. We believe US rates will move higher in response, with a high probability that this will be disruptive to fixed income in general – and probably also to wider risk assets.

With summer having arrived and markets in a sleepy holding mode for now, there’s a warning for anyone falling asleep in the sun: when things hot up, it’s easy to get burnt!