MACRO MONTHLY DEBT: VIRTUOUS CYCLE OR VICIOUS SPIRAL?

Transcription

1 MACRO MONTHLY DEBT: VIRTUOUS CYCLE OR VICIOUS SPIRAL? JUNE 218 We are far more positive than the market on the outlook for the global economy, given that in our view there is little justification for the aggressive recent decline in sentiment and valuations. For recession fears to be real, either higher inflation or a severe growth shock would be needed. However, the outlook for inflation remains subdued. Furthermore, the increased tariffs so far announced by the world s largest economies in recent weeks are relatively small. After a decade of easy monetary policy from the US Federal Reserve (Fed), the world has too much debt, and a lot of it is held in US dollars. High global debt levels are a constant threat to the global economy. So when there is a short squeeze in US dollars, the consequences of it can be particularly nasty for economies that have borrowed heavily in the currency as their liabilities become harder to repay. In our minds the damage being inflicted on emerging markets is a mini version of the 213 taper tantrum. However, this time round we expect it to be short-lived due to emerging market balance sheets being in much better shape, Fed rate rises being now fully priced in and a much more synchronised global recovery. In short, the US dollar s ascent should soon run out of steam. MINI EM TANTRUM TO BE SHORT THE TAPER TANTRUM S VIRTUOUS AND VICIOUS CYCLES Virtuous Cycle Vicious Spiral Creditworthiness improves Debt grows faster than income Debt burdens too high Creditworthiness reduced Debtor obligations > Cash flows Interest rate above R* Asset prices rise Spending rises Collateral v alues and incomes drop Assets sold and spending cut Rising dollar Income and net worth rises Asset prices fall Source: Old Mutual Global Investors, as at 3 June 218. US DOLLAR ASCENT TO REVERSE The spread on emerging market debt is as wide as it was during the taper tantrum, when half the world was undergoing austerity and households were deleveraging. We continue to add risk in emerging market debt and think these are great entry levels. HOW DID A VIRTUOUS CYCLE BECOME A VICIOUS ONE? Monetary policy didn t tighten financial conditions until early February, despite rate hikes from the Fed. This was because global growth was strong and synchronised, while the attitude towards risk was positive. Yields were rising in the US but they weren t high enough to encourage repatriation of US dollars as investors investing in international markets. As we moved into 218, growth across much of the world slowed from very strong levels, except Page 1 of 5

2 for America. The US benefited from a large, front-loaded fiscal stimulus package under which corporation tax fell and disposable income increased this sugar rush largely protected the country from what was happening in the rest of the world. This meant that the Fed, faced with strong growth, low unemployment, loose financial conditions and low unemployment, rightly saw no reason to deviate from its gradual tightening path. GS CURRENT ACTIVITY INDICATORS 8 7 World indicator Developed market indicator Emerging market indicator Source: Bloomberg as at 1 June 218. The rising deficit also had another impact. The US Treasury decided to fund the extra government spending by issuing Treasury bills and front-loading it. At the same time as this was happening the Treasury was rebuilding cash reserves that had been drained during last year s debt ceiling standoff. All this issuance drained liquidity and was the chief cause of the jump in rates. US TREASURY CASH BALANCE AT THE FED US Treasury cash balance Federal Reserve account Source: Bloomberg as at 1 May 218. EMS WITH TWIN DEFICITS TARGETED The rise in rates meant the emerging market versus developed market trade suddenly looked unappealing. You had a strong American economy and, for the first time in a decade, got paid a positive real rate for bonds with short-term maturities cash was an investable asset class again. US stocks outperformed global indices as companies enjoyed lower taxes and announced stock buybacks. Offshore dollars were also repatriated. Meanwhile, with no fiscal stimulus packages and threats of trade tariffs, the rest of the world looked bleaker. The phenomenal pace of growth seen in the final three months of 217 couldn t be sustained. Page 2 of 5

3 MS GLOBAL TRADE LEADING INDICATOR VS CPB WORLD TRADE CPB world trade monitor total volume index (%) (LHS) (%) Morgan Stanley global trade leading indicator (RHS) Source: Bloomberg as at 1 May 218. FRONT END OFFERS GOOD VALUE Emerging markets running twin current and fiscal deficits were targeted and liquidity quickly disappeared as market makers stepped aside. As the rest of the world owned plenty of US dollar debt, it was exposed to a rising greenback, rising rates and less liquidity as dollars found their way back to the US. Countries were borrowing monetary policy from the US central bank yet growth wasn t strong enough to cope with Fed rate hikes and shrinking balance sheets. WHAT RETURNS US TO A VIRTUOUS CYCLE? As in 215, policy and economic convergence is a dangerous game when there is so much US dollar debt in the world. For policy to converge we need: (i) Stronger growth outside of the US. We share the view of the European Central Bank (ECB) and the Bank of England that the slow start to 218 won t persist. Expectations (as always) were simply too high going into the year and domestic demand remains strong. In emerging markets the data has been weak so we need to see some pick up in the second quarter data. Signs that China is stimulating its economy or a thawing in trade disputes would help. In the US the fiscal stimulus, and its boost to growth, will start to wear off towards the end of the year. (ii) Fed hikes to get priced out, or for the Fed to acknowledge that the neutral rate of interest, or the rate at which real growth expands at its trend rate and inflation is stable, is lower. We think Fed hikes are fairly priced in and the front end of the curve, or bonds with short-term maturities, looks good value. (iii) A weaker US dollar, improving the creditworthiness of those sovereigns and companies who have borrowed in the US currency. We still expect a weaker dollar as the US asks the rest of the world to fund its deficits. SELLOFF CREATES VALUE IN EM FRONT END OFFERS GOOD VALUE Given our expectation that growth outside of the US will pick up, the US dollar is in a structural bear market and the Fed is fairly priced, we have high conviction that the selloff in emerging markets is a great opportunity to add emerging market assets. We have increased risk in the fund by adding emerging market assets in hard and local currency, predominantly in Latin America and South Africa. We retain US dollar shorts versus Scandinavian and emerging market currencies given our view on global growth returning and for a thaw between the US and China on trade. We have steepeners in Europe and the US on the view that central banks will keep policy rates more accommodative than consensus expectations, and term premium will come back into bonds with long-term maturities as the ECB purchases end and safe haven plays get taken off. Page 3 of 5

4 THE MODEL PORTFOLIO ALPHA FACTOR CONVICTION WEIGHTS (PER SECTOR) DIRECTION Exposure (weighted duration or %) Risk Cont. (TE,bps) Risk Cont. (%) CREDIT NET LONG 1.15yrs US / EUR Coco bonds 4% LONG.25yrs 14 5 Hard Currency EM 6% LONG.8yrs Developed Market Rates NET LONG -.35yrs Greece 2% LONG.4yrs 4 15 US 25% LONG 2.1yrs 8 3 Germany 2% SHORT -1.4yrs 27 1 Japan 5% SHORT -.4yrs 2 1 UK 2% SHORT -.65yrs 15 6 Australia 5% SHORT -.2yrs 8 3 Canada 5% SHORT -.2yrs 3 Emerging Market Rates - Local Currency NET LONG.85yrs Argentina 1% LONG.5yrs 1 Brazil 15% LONG.1yrs 5 2 South Africa 25% LONG.25yrs 14 5 Indonesia 2% LONG.15yrs 4 2 Mexico 15% LONG.2yrs 2 1 Russia 15% LONG.1yrs 3 1 FX (vs. USD) NET LONG 13.% Argentine Peso 5% LONG.75% 2 1 Brazilian Real 1% LONG 1.25% 9 3 Canadian Dollar 5% SHORT -1.% -5-2 South Korean Won 5% SHORT -2.% -8-3 Colombian Peso 5% LONG 1.% 6 2 Egyptian Pound 5% LONG.5% 1 Indian Rupee 5% LONG.5% 2 1 Indonesian Rupiah 5% LONG 1.5% 4 2 Mexican Peso 1% LONG 1.5% 7 3 Pound Sterling 1% LONG 3.% 9 3 Russian Rouble 15% LONG 2.% 14 5 South African Rand 1% LONG 1.% 9 3 Swedish Krona 1% LONG 3.% 9 3 Inflation NET LONG 1.8yrs Japan Breakeven 3% LONG.7yrs 7 2 European Breakeven 3% LONG.6yrs 8 3 US Breakeven 4% LONG 1.yrs Source: Old Mutual Global Investors, as at 3 June 218. Page 4 of 5

5 FUND MANAGERS Mark Nash and Nicholas Wall have managed the Old Mutual Global Strategic Bond Fund (GSB) since 1 August 216. MARK NASH Mark is head of fixed income at Old Mutual Global Investors (OMGI). He joined OMGI on 27 June 216 from Invesco, where he had worked since 21. At Invesco, he was most recently head of global multi-asset portfolios. Mark is a CFA charterholder and has a chemistry degree from the University of Nottingham. NICHOLAS WALL Nicholas joined OMGI as portfolio manager in July 216. Prior to joining the business Nicholas worked as a fund manager in the global macro team at Invesco, since 26. He is a CFA charterholder and has an economics degree from the University of York. Page 5 of 5 Building better solutions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back any of the amount originally invested. Because of this, an investor is not certain to make a profit on an investment and may lose money. Exchange rate changes may cause the value of overseas investments to rise or fall. This communication is issued by Old Mutual Global Investors (UK) Limited (OMGI), Millennium Bridge House, 2 Lambeth Hill, London, United Kingdom, EC4VP 4WR. OMGI is authorised and regulated by the Financial Conduct Authority. This communication is for information purposes only. Nothing in this communication constitutes financial, professional or investment advice or a personal recommendation. This communication should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the document. Any opinions expressed in this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or companies within the same group as OMGI as a result of using different assumptions and criteria. OMGI 6_18_232