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The financial markets today: How to cope with low / negative interest rates

Last summer, the machine has become unsettled. The financial markets have been in the doldrums, everything (Fed, ECB, China, Yuan, oil, etc.) has become subject to a negative interpretation. It is therefore easy to understand why we have witnessed the repricing of risk and the implementation of portfolio protection, and even in some cases the liquidation of positions. Why have we reached this situation? Was it entirely justified?

The decline in oil prices is frightening since it weakens many countries and generates fears of defaults and bankruptcies in the energy sector, with potential implications for the banks. All the benefits of the oil counter-shock, which are nevertheless very real and substantial, seemed derisory when we compared them to the dangers that it represents. Central banks have failed to provide reassurance since their policies show no real medium-term effectiveness. The BoJ has put its interest rates in negative territory, the ECB has implemented a whole raft of measures, and the Fed, which no longer speaks with one voice, has not managed to restore any room for manoeuvre or provide reassurance on growth. China is giving cause for concern, and the management of the yuan (substantially modified) has puzzled many observers. Moreover, macroeconomic forecasts were for a long time far too optimistic, and recession fears have resurfaced, notably in the United States. Concerns regarding banking systems (too fragile in some cases, too involved in the energy sector for others…) have resurfaced. Negative rates are more worrying than reassuring, and the Brexit scenario has become a more palpable reality since a deadline has been set, further propelling this risk to the centre of discussions.

All in all, the markets identified many immediate dangers, and we can easily understand why the financial markets were fragile. However, it was not only a question of fragility, but the risk of collapse of the global economy and the banking systems. We do not share these fears, even though it is important to recognise that the economic and financial environment has deteriorated significantly, thereby fully justifying the macro-hedging strategies developed in our portfolios for more than 6 months now (long US Treasuries and long Bunds, long volatility, long USD and JPY, long cash USD, long gold).

The purpose of this article is to analyse and assess the fears that have encouraged the decline in equities and financial stocks, the widening of credit spreads and the contagion to equities, the increase in volatility, the collapse in the long yields of safe countries such as the United States and Germany… in short, everything that is at the origin of the increased risk aversion and that prompted a review of the construction of portfolios, macro-hedging mechanisms, stress tests and liquidity stress, or even the basis of asset allocations.

ITHURBIDE Philippe , Senior Economic Advisor

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