BlueBay AM: ‘Transitory’ clings on for now

3 september 2021

Mark Dowding, CIO at BlueBay Asset Management, has issued his latest market commentary. This week, he focuses on the recent Jackson Hole symposium, central bank asset purchase programmes and the ‘back-to-school’ trade.

US Treasury yields declined over the week in the aftermath of Federal Reserve (Fed) chairman Powell’s address at the Jackson Hole symposium. In essence, Powell’s speech contained relatively little new information over and above recent Fed minutes – hawkish on tapering QE purchases but dovish on future rate hikes – with added emphasis on disentangling the lift-off conditions for the respective policy tools.

On the outlook, Powell sounded positive on the US economy while acknowledging the challenges facing the ongoing recovery, such as the Delta variant. The commitment to keeping interest rates low until the Fed’s more stringent maximum employment threshold is met was taken dovishly by the market. Risk assets responded well with US equities making new highs and credit spreads tightening.

On the data front, prints in the US continue to err on the soft side with some green shoots. The conference board consumer confidence index fell back to March levels but fared better relative to the University of Michigan print late last month.

On the business side, the ISM survey continues to point towards a robust rebound in manufacturing, although some subcomponents, such as employment, showed weakness. Today’s payroll report should provide some more colour in that respect.

Despite the uncertainties regarding Covid, bottlenecks in supply chains and hiring difficulties, the underlying trend in data remains firm with supply and demand mismatches having the potential to manifest further upward pressure on prices in the near term. We remain convicted US yields will rise as we move towards year-end.

Europe

A higher-than-expected CPI print for the eurozone (3% year-on-year versus the 2.7% expected) spurred ECB hawks into action. Holzmann (Austria), Knot (Netherlands) and Weidmann (Germany) all highlighted upside risks to inflation and called for an end to the ECB’s Pandemic Emergency Purchase Programme (PEPP) and a halt to further monetary easing.

We would, however, highlight that while these governing council members bear some influence among ECB ranks, it seems policy is still firmly driven by the executive board, and last week’s comments from chief economist Lane – while appearing to suggest that PEPP purchases may slow following the monetary policy meeting in September – reinforced that the overall policy stance will remain very accommodative.

UK

UK economic data has held up well in the face of rising Covid cases over recent months, which have now started to fall on a seven-day moving average. Moreover, high-frequency data shows credit and debit card purchases are at 93% of February 2020 levels, while flights, retail footfall and restaurant bookings continue to rise.

However, as with much in the developed market space, price pressures continue to rise, with the UK hit with the double whammy of Covid and Brexit red tape on supply chains and hiring. Pictures of empty grocery shelves are becoming all too common, exacerbated by the lack of workers in key sectors.

Notwithstanding the end of the furlough jobs scheme this month, we believe BoE policymakers will have a keen eye on these developments, given upside risks to already lofty inflation forecasts in Q4.

Credit & FX

Credit markets were generally on firm footing with CDS indices in both Europe and the US seeing tighter spreads. Corporate cash credit did particularly well in the US, retracing recent weakness particularly in dated maturities following the messaging from Jackson Hole, and due to a much quieter week in the new issue market.

Supply has already picked up in Europe and will likely increase quickly next week in the US, but with investor cash balances high in preparation, and generally defensive positioning, this shouldn’t weigh on credit spreads.

Since our corporate positioning is currently relatively modest, we will look to selectively take advantage of interesting opportunities over this seasonally busy period. We also see scope to exploit certain dislocations in the secondary market created in the lead up to a busier September.

FX markets reacted positively to the Jackson Hole meetings. The dollar has weakened and currencies like the Canadian dollar, Norwegian krone and most in the emerging markets, have performed well. Longer-term, we remain biased to see the greenback stronger, but as investors return to their seats from summer holidays, the positive tone has room to run. 

We remain positioned modestly risk-on, but continue to have a negative view on the Chinese renminbi as stress in the real estate market remains elevated and activity data shows growth under pressure. Interest rates in China have further to fall, but we are relatively sanguine on the medium-term outlook and have a degree of confidence that policy setting will prevent a serious escalation. 

The read-through into emerging markets follows the same theme we described for FX. Powell’s speech has been a tide that has lifted all boats, leading to spread compression in sovereign credit. The ‘back to school’ trade in September is likely to see this trend continue, but the main risk is an intensification of stress in China. 

Looking ahead

We remain confident with respect to the economic outlook. We continue to analyse country-level data to try to understand the risks to this view, which could be stemming from the spread of the Delta variant. The good news is that there are signs that the US Delta wave is losing traction – positive test rates and hospital admissions are falling, total hospitalisations seem to have reached a plateau and case growth is slowing.

Elsewhere, third-round ‘booster shots’ in Israel have put a halt to case growth. In Europe, infections and hospitalisations also seem to have hit a plateau, with the EU commission proudly announcing that 70% of the adult population is now vaccinated.

However, there remains fragmentation among member states, with France, Spain and Germany having comfortably vaccinated most of their adult populations, while eastern counties such as Bulgaria and Romania linger on only 20% and 32%, respectively.

Consequently, it seems appropriate to retain some cautious optimism with respect to the ability of societies to manage the virus in the months ahead. Overall, we remain optimistic and are hopeful that the reflation theme will have further to run in the context of the ‘back to school’ trade.

The definition of ‘transitory’, according to the Google dictionary, is ‘not permanent’, which leaves the word a bit meaningless as nothing is really permanent. With price pressures showing little sign of abating, we wonder how long ‘transitory’ has left in the policymaker lexicon.