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About six weeks ago, the European Central Bank (ECB) confirmed that it was unwinding its quantitative easing programme, based on the fact that it was seeing a recovery in Eurozone economy. A move which markets were expecting given the yet benevolent data. However, market participants are more than conversant by the fact that within financial markets things move very fast and an investment decision that were based a week ago can easily be reversed on an unforeseen event.
In fact, in the last weeks of 2018, we were faced by huge concerns in terms of global growth as a swath of data was posing risks to the downside in terms of sustained economic growth. This data, amongst other factors, has pushed the once hawkish Federal Reserve (Fed), towards a more dovish tone in terms of interest rate hikes. The Fed signaled fewer hikes in 2019.
Given the increasing risks what would be the ECB’s stance?
Undoubtedly, it is undebatable given the recent data risks have skewed to the downside. In my view, the ECB needs to acknowledge the fact that risks did increase and a hawkish tone will definitely not be digested positively by markets, even on the back of the recent comments put forward by the Fed. We are not expecting that the ECB will re-start a wave of QE, but as market participants and given the recent momentum we would expect a tone that calms market fears, a tone which re-assures that the ECB will be there to intervene if risks will put further pressure on economic growth. Undoubtedly, the past years of easiness have helped the cause with Eurozone unemployment just below 8 per cent to date from the highs of just over 12 percent in 2013.
Indeed as expected, in yesterday’s press conference Mario Draghi, reaffirmed the central’s bank stance to keep interest rates at the current levels and longer if necessary.
Following a dovish tone by the Fed and ECB how should credit markets react?
Following the comments by the Fed, as expected we experienced a tighter US Treasury curve, a weaker dollar, which translated in higher bond prices. Given the weaker dollar we have experienced a good retracement in emerging market bonds, which were the prime beneficiaries following a harsh 2018. Likewise, we have seen US investment grade bonds trade tighter following a tighter US curve, while European high yield was also a prime beneficiary following the widening in spreads registered in the second half of 2018.
Going forward, we believe that given the monetary politicians will maintain a relatively supportive tone, we should continue to see credit markets improve following a catastrophic 2018. Once again, on the basis that the dollar trades within a narrow range, we should see EM debt recover strongly in 2019 as has been the case in the first 3 weeks of the year so far. Undoubtedly, other factors will also be pivotal, primarily the trade-war saga which was the prime echo in 2018, and which has dampened the path of economic growth. A word of advice, being selective and diligent will fulfill your return expectations.
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