The US – No Early Exit from Stimulus.
Federal Reserve officials in recent weeks have affirmed they see no imminent change in the central bank’s monetary policy stance. Although the vaccine rollout started at a good pace in the US, Fed officials have said short-term interest rates are likely to stay near zero while their bond-buying stimulus should continue through 2021. We believe rates have further room to widen gradually amid fiscal stimulus but think the FED won’t tighten monetary conditions before the virus is over. In that regard, we look forward to hearing the Fed’s comments on widening Treasuries.
ECB – What They Didn’t Discuss.
The ECB delivered a marginally less-dovish meeting last Thursday, with policy parameters and PEPP purchases at €1.85 trillion until at least March-end 2022 unchanged. The envelope may be up- or downsized, depending on the virus situation or inflationary pressures. Interestingly, the ECB neither discussed how inflation can increase from here, nor how the PEPP shall end after the pandemic – two key questions for investors. We see an early withdrawal as unlikely but instead believe the program may persist for even longer, resulting in persistent deeply negative interest rates. While the ECB refused to answer the questions directly, it appears clear that some sort of “control” of spreads is in place, executed via the composition of purchases. As such, large divergences among EZ sovereign bonds are unlikely for the time being.
Italian Politics – Uncertainty Remains Despite Confidence Vote Win.
The Italian government survived the confidence vote in the Senate on Tuesday last week, albeit only with a relative majority. This allows the cabinet to continue but complicates policymaking when an absolute majority is needed to pass legislation, such as the crucial vote on deficit expansion. The next steps for PM Conte are to strengthen his coalition with a more solid and reliable majority. Thus, political negations are to continue in the coming days. Overall, whilst the risk of a snap election is low, Italy is left with a weaker government to lead the country during the pandemic. This is particularly complicated in the context of the Recovery Plan if political efforts are concentrated on minimizing instability rather than on long-term reform planning and implementation.
Markets – Time for caution
Risk markets appear vulnerable, as equity and credit markets declined for the second Friday in a row amid prolonged lockdowns. With expensive equity valuations, tight credit spreads and longer positioning, the bar set for a modest repricing in case of a worsening virus or hawkish central bank tone is low. Accordingly, we reduce positions with unfavourable risk/reward or drawdown potential, decreasing our overall investment ratio to <60%. For the reflation scenario, we continue to focus on high-conviction investments in banks, energy and travel with attractive risk/reward.
To read more on our latest views, please see our Silver Bullet | The New Bond Vigilantes or visit our Insights section.
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