BlueBay AM: Jabbing but no knockout blow

BlueBay AM: Jabbing but no knockout blow

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By Mark Dowding, CIO at BlueBay Asset Management

Core government bond yields moved higher over the past week, buoyed by hopes of an interim US-China trade deal. The calmer macro backdrop also propelled the US stock market to record highs and the Chinese renminbi traded through the critical threshold of 7 versus the US dollar.

In general, the direction of travel has been positive on US-China trade relations with both sides showing more flexibility. From what we have gathered from local sources, China’s stance is slightly softer now. It is willing to shore-up agricultural purchases and make some concessions.

As part of the deal, the existing tariffs would need to be rolled back over time. But will Trump play along to secure a ceasefire?

While the White House could cancel the December tariff threats and roll-back some of the existing tariffs as a gesture of goodwill, it is difficult for us to see it throwing in the towel just yet. Any major softening in stance on trade could chip away at diehard support for Trump into the presidential election.

Taking a step back, even if a ‘phase-one’ deal is reached, we do not see a quick resolution to those central issues, such as technology transfer.

In the US, jobs data posted a big surprise to the upside despite the GM strike. We continue to see the recent jobs growth as consistent with our thesis that the weakness in US manufacturing has spilt over to neither the labour market nor the US consumer. ISM non-manufacturing also came in above market expectations at 54.7, a two percentage point jump from the September print, lifted by a pick-up in business activities and employment.

On the political front, with a few democratic candidates having dropped out of the presidential nomination race, Elizabeth Warren runs just slightly behind Biden in polls. However, if the race comes down to Trump and Warren, current polling suggests Trump still has a decent chance of beating Warren in key battle states that will likely sway the electoral college votes to his favour.

Turning to Europe

Ex-IMF boss Christine Lagarde took office as the new president of the ECB. While Draghi has left some big shoes to fill, we trust monetary policy will continue to be in good hands under Lagarde’s leadership.

One of her very first actions was to send a warning shot to Northern Europe by applauding the ECB’s policy of favouring jobs growth over high savings rate and advocating an expansionary fiscal policy.

We remain convinced the spirit of solidarity will continue to drive European integration, and just this week the current German finance minister Olaf Scholz finally gave the green light to an albeit light version of a European bank deposit insurance scheme.

Busy EU election calendar

The next few months also mark key elections across the continent. Spain goes first this weekend, with the intention of breaking the current political deadlock that has persisted since April.

Polls suggest more fragmentation than earlier this year, to current PM Sanchez’ detriment, but ultimately we see minimal impact to Spanish government bond spreads as the economy chugs along.

In the UK, parliament is now dissolved and campaigning for the mid-December general election is in full swing. The Labour party have set their stall early, promising to cut university fees, kick-start a green revolution and get Brexit done in six months.

The Tories have had a slower start, but ultimately their appeal lies in getting Brexit fast-tracked through parliament with a deal already at hand. With four major parties vying for votes, campaigning is likely to be fraught, and current polls show the Tories winning a slim majority.

However, it is worth remembering that the Tories found themselves in a similar situation in 2017, only to let things slip – a stark reminder that things can change very quickly in ‘purdah’.

In most outcomes, we see Gilt yields moving higher over the medium-term – as expansionary fiscal policy plays a bigger role and ‘No Deal’ (at least till the end-2020) is off the table.

Shrinking spreads

Investment-grade corporate credit spreads in Europe have continued their march tighter as a combination of underwhelming primary supply, ongoing inflows and the resumption of the ECB CSPP programme all provided a strong technical tailwind for the asset class.

The ongoing search for yield led to an outperformance of eligible corporate bond spreads versus synthetics as well as strong curve flattening – themes that we believe will continue to work for the foreseeable future.

Looking ahead

Despite global risk assets making new highs on what seems like a daily basis, we can’t help but sense a degree of complacency taking hold. While many market participants will point to a near-term improvement in the macro landscape, we believe there continues to be a high degree of fluidity and we remain sceptical on how long these goldilocks conditions can last.

With ongoing sensitivity around economic data and valuations at the highs in many risk assets, as we move into a more illiquid part of the year, we continue to take the prudent course and realise gains where appropriate.

We have a string of policy events and economic data points to potentially drive price action into year-end, and for that reason, running only moderate amounts of directional risk and focusing more on idiosyncratic opportunities makes sense to us.