BlueBay AM: Batting away Covid concerns

27 augustus 2021

Mark Dowding, CIO of BlueBay Asset Management, has issued his latest market commentary. This week, he focuses on Federal Reserve and ECB asset purchase programmes, reflation, and the upcoming German federal election.

The past week has seen renewed interest in the reflationary theme driving yields and equity prices higher, albeit in relatively thin summer trading. 

A sense that the Fed’s taper announcement will be delayed until November, given uncertainty surrounding the spread of the Delta variant, supported sentiment for risk assets and saw the yield curve bear steepen over the past several days. The decision by the Federal Reserve to hold its annual Jackson Hole meetings in a virtual format helped to underpin this narrative, on the assumption that Powell’s address would contain relatively little new information. 

Recent data prints have shown some softness, though part of this may be explained by forward-looking worries and uncertainties with respect to Covid. Much of the rest of any downside in the data appears largely explained by bottlenecks in supply chains, which have been impacting production. 

The underlying trend in data remains firm and there is a sense that, in many areas, there is an excess of demand relative to an ability to supply, which could well manifest in further upward pressure on prices in the near term. 

Europe

Comments from the ECB’s Lane appeared to suggest that PEPP purchases may slow following the monetary policy meeting in September. This may be debatable, though it strikes us that the hawks on the Governing Council are unlikely to want to extend PEPP and are similarly reluctant to announce additional asset purchase programmes at the current time. 

Activity data across the eurozone remains relatively upbeat and there is optimism for the outlook through the end of the year, with fiscal policy also set to benefit the growth outlook in the quarters to come as the Next Generation EU funds are deployed across the continent. 

Momentum continues to swing towards Scholz and the SPD with just under one month to go until the German elections. Broadly speaking, this vote is unlikely to have much significance for financial markets, though were a coalition between the SPD, the Greens and Die Linke to be formed (so-called ‘Red, Red, Green’), then this could alter the landscape. 

This would infer a more decisive turn to the left and an agenda that may be more fiscally accommodative. This could help facilitate a bigger change to the EU fiscal compact rules and could be beneficial for EU spreads, whilst being detrimental for Bunds on a relative value basis.

However, this outcome remains quite unlikely for the time being. Meanwhile, other outcomes would suggest more of a broad continuation of the policy framework followed by Merkel and an extension of the status quo.

Credit

Credit markets have remained relatively active with respect to new issues during August, as issuers have taken advantage of low yields to fund early, ahead of the seasonal uptick in supply which normally occurs in September. Spreads have drifted a little wider in recent days and there seems scope for this to continue. 

However, with broader risk appetite remaining upbeat, it may be that September supply could be more subdued than expected. From this point of view, we are inclined to add on weakness and take advantage of attractively priced new issues. 

Nevertheless, credit markets in general remain largely becalmed with volatility declining. Investor positioning appears somewhat cautious ahead of the anticipated Fed taper in the months ahead.

Yet, with yields remaining low and liquidity abundant, it would seem that there are plenty of potential buyers should there be any pronounced weakness in the market.

Currencies

FX has also been relatively subdued. A reflationary theme hasn’t benefited EM currencies as much as has been the case in the past, even as commodities have rebounded. Elsewhere, AUD and NZD continue to be impacted by the growing realisation that zero-Covid policies seem doomed to fail, meaning that lockdowns may need to be extended until the end of the year, as vaccination rates take time to reach the levels seen in Europe and the US.

Meanwhile, China appears to have been more successful in limiting domestic cases by imposing harsher lockdowns in locations where a cluster appears. Given the high degree of transmissibility of the Delta variant, one wonders how long Beijing will be able to hold this line. As policymakers continue to struggle with this, we see scope for monetary policy easing by the PBOC, which could benefit Chinese rates but detract from the renminbi.

Looking ahead

We remain confident with respect to the economic outlook. However, we have spent further time analysing country-level data to try to understand the risks to this view, which could be stemming from the spread of the Delta variant. In the short term, it appears that infection numbers may have peaked in Florida, which has been at the forefront of the rise in US cases.

In Europe, infections and hospitalisations also seem to have hit a plateau. However, it would appear that there remains scope for further acceleration in states and countries where vaccination rates are much lower. It strikes us that with an ‘R’ number for the virus around 8, it would appear that 90% of the population needs to have Covid antibodies in order to reach a point where a stable equilibrium is attained.

This view appears to be supported by analysis of UK antibody data. Elsewhere, a recent acceleration in infections and hospitalisations amongst the vaccinated population in Israel has caused concern. However, this appears to be addressed through third-round ‘booster shots’, which are currently being administered.

Consequently, it seems appropriate to retain some cautious optimism with respect to the ability of societies to manage the virus in the months ahead. Yet uncertainty regarding winter conditions, as the weather in the northern hemisphere cools and individuals move indoors in greater numbers, is an ongoing source of concern. 

Similarly, there is the risk of further variants emerging, though some studies appear to support the notion that Covid has already evolved to reach its ‘optimum fit’ in the Delta form, meaning this could become a fading worry.

We remain optimistic and are hopeful that the reflation theme will have further to run in the context of the ‘back to school’ trade. 

Meanwhile, it has been a week to take inspiration in the endeavours of the incredible athletes competing in the Tokyo Paralympics. We can only be amazed at the talent and story of perseverance and triumph over adversity that has been demonstrated.