After what we could definitely call a tough year for investors, the financial markets have been characterised since the beginning of the year by a combination of a sharp rebound in risky assets and a decline in sovereign Core bond yields.The German 10yr has declined to 0.04% and the US 10yr is now close to 2.5%.
The two main driving forces behind these trends are:
- The change in the Fed’s tone due to fears regarding global growth.
- Risky asset valuations that have once again become attractive after the very steep correction of 2018.
This rally has not been justified by an improvement in the fundamental picture. Growth forecasts have been revised downwards across major economies. The downward revision of growth has been particularly pronounced in the euro area. This riskier growth environment has forced central banks to adopt a more dovish tone. Muted inflation gives also central bankers room for manoeuvre. We could now consider that monetary policy tightening in developed economies is over:
- We expect the Fed’s next move to be a cut. The Fed signalled there will be no rate hikes this year and also announced that its balance sheet shrinkage will be completely interrupted from September.
- We do not expect the ECB to hike interest rates. In contrast to the Fed, the ECB has not even started the normalisation of its monetary policy. We believe that the ECB’s asset purchase program was ended last December for technical reasons. At its last committee, the ECB has changed its forward guidance (rates will “remain at their present levels at least through the end of 2019.") and announced new funding for banks. The ECB is now in a tricky situation and will have to face a slowdown without previously normalising its monetary policy.
The ECB and the Fed have sent strong signals for lower rates for longer. The low-volatility and low-yield environment will support the “search for yield” as long as investors remain comfortable with fundamentals. Investors are now expecting the dream scenario of growth close to potential and very accommodative monetary policy. We could expect some stabilisation in Q2/Q3 on the back of the positive impact of Chinese stimulus and ongoing strength of domestic demand in developed economies. Against this backdrop, sovereign yields could have some (very limited) upside. In any case, the landscape is pointing to a deceleration in global growth. The next game changer will be a less strong US consumer. The US was explicitly cited by Draghi as a risk to the Eurozone economic outlook!