Outcome of EU summit Supports European assets
UIC increases overweighting of euro
RoRo meter still at 3, Risk positioning remains neutral
The Union Investment Committee (UIC) is maintaining its neutral risk positioning (RoRo meter at level 3). It does not believe that there have been any major changes to the economic situation, monetary policy or the pandemic compared with the previous month. The existing positions in the model portfolio – such as in the spread markets and absolute return – have therefore been reaffirmed.
However, the UIC views the outcome of the latest EU summit as a milestone in the battle to tackle the economic fallout from coronavirus. As well as reaching agreement on the multi-annual financial framework (MFF) for the next seven years, leaders also struck a deal on a €750 billion package of loans and grants dubbed ‘Next Generation EU’ (NGEU). This move should enable growth to accelerate by up to 1 percentage point per year for the next three years and reduce the risk of a further crisis materialising in Europe in the wake of coronavirus.
The EU is also making institutional changes, for example providing the option of generating its own revenue. Despite the difficult negotiations, the deal ultimately represents political progress too. The summit shows that the EU is capable of taking action and willing to coordinate its fiscal policy. This is positive for Europe and takes the pressure off the anti-crisis policy of the European Central Bank (ECB), which in turn should benefit European assets.
Economy remains fragile
The economy has recently rebounded strongly. External and our own leading indicators have been on a steep upward trajectory from a low level. Nevertheless, the economy remains fragile. In the US, the immediate relief provided to households by the CARES Act is due to stop at the end of July. So far, these payments have offset a good proportion of the decrease in disposable income. When combined with the regular support, net income actually rose. If agreement on an extension is not reached in the highly charged political atmosphere ahead of the election, the economy may suffer as a result.
Another factor is the uncertainty surrounding the pandemic. High rates of infection (e.g. in the US) will necessitate stricter countermeasures and therefore trigger an economic slowdown. It is important to monitor this mechanism carefully, especially as the effects do not all materialise at the same time. In August, a scenario could therefore arise in which the economic data has worsened but infection rates have improved again.
Wait-and-see monetary policy
After expanding the pandemic emergency purchase programme (PEPP) in June, the ECB did not make any changes to monetary policy at its meeting in July. The expansion should have bought the ECB some time, so only small interventions are likely for the time being. However, the central bank is ready to take further action if the situation deteriorates.
The same applies to the Federal Reserve (Fed), which would not shy away from implementing further measures if needed and would even go as far as introducing yield curve control. The temporary reduction of the US central bank’s balance sheet should therefore not be misinterpreted. It is a reaction to the declining use of US dollar liquidity lines by friendly central banks that were offered these lines at the height of the coronavirus crisis. There is no end in sight for accommodative US monetary policy.
Chart of the month: Milestone – EU reaches agreement on multi-annual financial framework and recovery fund
Equity weighting within the asset classes
Opportunity to earn carry
We anticipate little movement in yields on paper from core eurozone countries. Issuing activity is likely to pick up going forward, but the resulting momentum should largely be offset by the ECB’s asset purchases. Low inflation risk and premiums associated with limited supply are capping yields on longer maturities. In addition to the support from the ECB, eurozone periphery bonds are also enjoying a boost from news of the European recovery fund, even though this had already been priced in to some extent ahead of the EU summit.
All in all, the market environment continues to favour assets that offer risk premiums. There is limited scope for spreads to narrow further, but the (traditionally quiet) summer months should provide an opportunity to earn the carry.
Selected opportunities for equities
The rally in the global equity markets continued, albeit at a slower pace than in previous months. After all, equities remain a key beneficiary of the ‘hunt for spreads’ and demand for investments in structural growth trends is undiminished. As a result, valuations have already climbed to ambitious levels, especially in these segments.
Recent data underpinned the stabilisation of profit expectations in the global equity markets. The reporting season for the second quarter of 2020 got off to a slightly better start than expected. But the economy and corporate profits have not yet picked up enough momentum to generate a tailwind that also supports value assets, including the broader equity market. Positive news about a coronavirus vaccine could provide fuel for a continuation of the upward trend in the medium term.
Gold rush continues
Equilibrium was restored in the global oil markets at the start of the third quarter of 2020 thanks to the fairly disciplined implementation of agreed output restrictions by the OPEC+ countries and drastic cuts in the production of shale oil by US companies. The rapid build-up of inventories caused by the weakening of demand due to coronavirus should therefore come to an end very soon. Indicators such as power generation and digger sales in China suggest that construction activity is recovering at a fast pace. However, we believe that this trend will not be long-lived. Sustained demand from investors and low real rates of return are shoring up the price of gold.
Euro still favoured
The agreement on the European recovery fund is providing a tailwind for the euro. Pound sterling will continue to be buffeted by the exit negotiations between the UK and the EU over the further course of the year, whereas the US dollar is likely to be increasingly influenced by the campaigning period in the run-up to the US presidential election in November. In addition, a twin deficit and flatter yield curve in the US and interest rates kept at persistently low levels by the Fed create a structural headwind for the greenback.
Convertibles still strong
The global market for convertible bonds continued on its upward trajectory in recent weeks. The average equity sensitivity currently stands at around 56 per cent. Valuations continued to rise but are generally still at a favourable level. In the US, primary market activity was initially brisk but turned quieter once the corporate reporting season started. Other regions saw a high volume of new issues on average. The placements met with good take-up in the market.
Unless otherwise noted, all information and illustrations are as at 21 July 2020.