After the financial crisis, the world is left with more debt overall, about 200 trillion dollars, almost three times the value of global GDP. A burden that affects economic growth, which is still fragile and weak. One reason for this situation is that interest rates have long been at zero. Which means no returns for cash and safer bonds. For investors, this is a difficult environment to move in and with which they will have to deal with for the long term. The market expects Mario Draghi to announce new accommodative monetary policy moves at the ECB meeting on Thursday. How to invest in this scenario? “Bonds are now a less liquid and more volatile market but there are still opportunities. In particular we look at three strategies: inflation-linked bonds, convergence between peripheral and core government bond yields, corporate bonds,” he explains to FIRSTonline Mauro Vittorangeli, head of fixed income at Allianz Global Investors.
FIRSTonline – What do you expect from Draghi on December 3rd?
First, the deposit rate cut, the market is already pricing it in and it would be disappointing if it didn't announce it. Two-year German bonds reached the minimum yield of -0,4% already discounting the 0,2% rate cut, perhaps already too much. We also expect the announcement of the extension of Quantitative Easing until 2017. Instead we have doubts that the ECB will be able to proceed with an increase in the quantity of purchases. If there should be, it will in any case be modest because, due to distorting technical factors linked to the liquidity of the bond market, the purchases by the ECB are making bond valuations excessively high. The transfer of the scepter from the Fed, which will probably start raising rates in December, to the ECB with the task of providing liquidity to support the global recovery, is definitively taking place in these days.
FIRSTonline – Is there coordination between the two sides of the Atlantic?
I doubt that there is a coordination of the central banks, they are all committed to exporting deflation outside. It is a natural handover: just as the Fed begins to increase the cost of money, the ECB feels even more the urgency to keep interest rates low. The real goal is in fact to keep the currency low. The central banks have now entered a currency war, the last one to take the field was in fact China in August. The risk is that the Fed may feel that the dollar is getting too strong. However, I believe that there is not much room to see the euro-dollar exchange parity break, because the US economy is not that strong. At the same time, on the Euro front, the European economy has a surplus trade balance which has greatly supported the currency.
FIRSTonline – How far will Janet Yellen, head of the Fed, raise interest rates?
I think we will see at most 1% upside by the end of 2016, much of which is already priced into by the market. Now US Treasuries are at 2,22%. They still have room to go up but we think a 3% return is close to the finish line.
FIRSTonline – When will the ECB also take the path of normalizing rates?
The ECB has managed to bring the convergence of financial conditions for companies in the Eurozone: Italian companies are finally starting to finance themselves at rates that are not too far from those in Germany. But inflation expectations are still not enough. This is why Draghi is still continuing on this path. We expect normalization not before the end of 2017-2018. The Eonia rate has a negative yield of 0,14% and, based on the current valuations of the forward market, the rate will return positive only in the fourth quarter of 2018.
FIRSTonline – What to expect for 2016 in terms of interest rate curve dynamics in the bond market?
We are reaching the maximum of monetary expansion in these days. Which means that for next year, while short-term rates will stay where they are, long-term rates will rise. The curve will become steeper again. If this were not the case, then it would mean that next year's growth will have failed to meet expectations.
FIRSTonline – For those looking at bond investment, how to move in this scenario?
Bonds are now a less liquid and more volatile market, but there are still opportunities. In particular we look at three strategies: bonds linked to inflation, the convergence between the yields of peripheral and core government bonds, corporate bonds. In the first case, securities linked to inflation, it must be remembered that if the ECB aims to increase consumer prices, this will happen. At the same time, inflation-linked stocks are now priced very low and we believe they have serious appreciation opportunities. However, we do not recommend direct purchase but to bet on the difference between the real and nominal yield to neutralize the negative effect deriving from a potential rise in long-term yields.
FIRSTonline – Where will inflation start from in Europe?
A decline as pronounced as the one we have seen for oil carries with it a "base" effect: when oil rises again, it will push inflation more than proportionally. Furthermore, this effect will be accompanied by the devaluation of the currency and the economic recovery which will in some way affect the wage structure.
FIRSTonline – What are the other two strategies you mentioned?
With the ECB extending the purchases of government bonds, the convergence of the yields of the debt of the peripheral countries and that of the core countries will continue. As regards Italy, we expect that in 2016 the BTP-Bund spread, now around 94, will rise to 80 basis points. At the same time, we see opportunities in European investment grade corporate bonds, which have arisen especially after the unexpected devaluation of China.
