Jean Boivin, Head of BlackRock Investment Institute together with, Elga Bartsch, Head of Macro Research, Mike Pyle, Global Chief Investment Strategist for APAC and Scott Thiel, Chief Fixed Income Strategist, all part of the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
A decision by the German constitutional court last week could potentially undermine the independence of the European Central Bank (ECB) – and threaten to fuel fragmentation within the euro area in the long run. This comes as the ECB’s actions to cushion the pandemic’s fallout already looked meek compared with the Federal Reserve’s. As a result, we are reviewing our overweight on euro area peripherals, or government bonds from southern-tier nations.
Sources: BlackRock Investment Institute, with data from Refinitiv, May 2020. Notes: The orange line represents the yield spread between 10-year Italian and German government bonds, calculated based on the are the Refinitiv Datastream 10-year government bond benchmark indexes for Italy and Germany. The yellow line represents the yield spread between U.S. investment grade credit and Treasuries, based on the option-adjusted spread of the Bloomberg Barclays U.S. Credit Index.
The German court gave the ECB three months to justify its 2-trillion-euro bond purchase program to the German parliament. Otherwise the Bundesbank – the ECB’s largest shareholder and bond buyer – would have to pull out of the program, the court said. The ruling put a spanner into the works of the ECB’s “whatever-it-takes” commitment – at a time when effective execution of policies is critical to safeguard the economy against damages from the coronavirus shock. As evidence of the vulnerability in the euro area’s hardest-hit economies, the yield spread between Italy’s government bonds and their German counterparts has been widening since late March despite the ECB’s stepped-up purchase program. In contrast, the U.S. investment grade credit spread declined from its March peak and has steadied since mid-April as the Fed’s pandemic response allayed credit concerns. See the chart above.
We have seen nothing short of a policy revolution in response to the coronavirus outbreak – in terms of speed, size and monetary-fiscal coordination. The successful execution of policies and programs is key – and the German court ruling may be a cautionary tale of how execution can be scuppered. Explaining itself to the German parliament shouldn’t be a problem for the ECB. Yet having to do so undermines its independence, a precondition for its “whatever-it-takes” stance. This is partly a consequence of the blurring of boundaries between monetary and fiscal policies – and particularly problematic in the euro area due to the lack of a joint fiscal authority. We had highlighted the crucial role of proper guard rails around policy coordination in dealing with the next downturn.
The bottom line: We are putting our view on euro area peripheral bonds on review despite relatively attractive valuations, as the German court case challenges the ECB’s independence. One offset to this risk: The ECB may up the scale of its bond purchases in coming months, which would support peripherals and euro area credit. Over the strategic horizon, we already see a diminished case for nominal developed market bonds due to the market reaction and policy response to the outbreak. Yields have fallen close to lower bounds, reducing return expectations and the ballast properties that traditionally help nominal government bonds cushion portfolios against risk-off episodes. The picture may look even gloomier over coming years if supply chain changes pick up pace, monetary policy is more accommodative and inflation risk rises. The court ruling offers a glimpse of challenges to effective policy execution – and adds to reasons to be wary of nominal government bonds.
Market Updates
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, May 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.
Fiscal and monetary policy action to bridge the economic impact of the coronavirus has taken shape – and now the priorities are 1) policy execution to ensure households and businesses actually receive the pledged funding; and 2) avoiding policy fatigue before the shock has passed. Markets have been torn between optimism on the tentative re-opening of some economies and caution on the still grim economic data. The U.S. administration, meanwhile, is making a calculus between the perceived political benefits of being tough on China and the risk of renewed stock market volatility.
Week Ahead
- Tuesday: U.S. NFIB Small Business Economic Trends survey; China, U.S. consumer price index
- Thursday: U.S. weekly initial jobless claims
- Friday: Univ. of Michigan surveys of consumers; U.S. retail sales, Empire State Manufacturing Survey, industrial production; China industrial output, retail sales; euro area flash estimate GDP
A trio of surveys in the U.S. – on small business, manufacturing and consumers – could provide important insights on the impact of the pandemic. Markets will watch out for any cracks in the financial system and elsewhere in the economy as virus infections climb. Data from China, including total social financing, could shed light on the recovery of the manufacturing and consumer sectors – or lack thereof – as the economy has cautiously re-opened.
BlackRock’s Key risks & Disclaimers:
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 11th, 2020 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.
Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL
MeDirect Disclaimers:
This information has been accurately reproduced, as received from BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.
The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.
If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.
