2016 has, so far, been a volatile and tumultuous year for financial markets. Only three weeks in, we have already seen a multitude of news events causing risk aversion to spike. These include, to name just a few, the tumbling price of oil, a myriad of different policy moves from the Chinese authorities, conflicting indicators of Chinese economic growth and subsequent fears of slower global growth, yet more idiosyncratic corporate events and geopolitical events.
While many of the news headlines have focused on the poor performance of equity markets, the impact on bond and currency markets has also been significant. Credit markets, high yield and EM have sold off year to date, while so-called risk-free rates, such as US treasuries, UK gilts and German bunds, have rallied. In addition, we note the huge surge in the volatility of currency markets.
The European Central Bank kept its monetary policy stance unchanged today, as expected. However, President Draghi commented that economic downside risks have grown “amid uncertainties about emerging market growth prospects”. He also emphasised second round effects from the oil price decline and their impact on inflation dynamics, which remain weak in the eurozone.
Against this backdrop, the prepared introductory statement notes that they will reassess their position in March – in our mind effectively pre-committing the ECB to ease further sometime this year. We will discuss what additional assets the ECB may purchase over the coming weeks.
Responding to a question in the press conference, Draghi praised the progress that Spain especially has made pushing through reforms. We remain positioned with a long Spain versus short Italy relative value trade and, on a longer-term fundamental basis, retain our preference for Portuguese government debt.
This week in the UK, a speech by Bank of England Governor Mark Carney dampened market expectations for a rate rise, seemingly reversing the view that he expressed last year. We are positioned with a UK curve flattener and believe that economic fundamentals still point to a rate rise this year. We are also long sterling versus the euro. The pound has tumbled this year and, based on both fundamentals and valuations, we believe this depreciation is excessive.
While this is proving to be a tough environment for emerging markets, we continue to see idiosyncratic opportunities in both rates and FX. A relatively long-standing view, India still remains one of our favourite positions, where we are long local currency Indian government bonds and Indian banks and are also long the Indian rupee. Elsewhere, given the recent volatility across EM currencies, we have reduced some of the USD short exposure in our long EM currency basket.
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