Pursuit of uncertainties

GLOBAL GOVERNMENT BOND STRATEGY

In January, intra-month volatility, in the light of a deteriorating global risk sentiment (signs of further slowdowns in China and the US), drove oil prices to 10-year lows. In a disinflation environment, many central banks adopted a dovish tone. The Riksbank, surprisingly, cut its key rate to 0.50% and the Bank of Japan to -0.10% (under certain circumstances).

Regarding the US, the Federal Reserve also adopted a dovish tone during the February Testimony in Congress. We have subsequently noted that the markets are not currently pricing in any Fed funds rate hike before 2017.

In addition, we expect the ECB to further ease its monetary policy next month to boost inflation prospects.

Long-duration stance via EMU core rates

In this context, the environment is supportive of core sovereign rates in the euro area. Despite an expensive German yield curve, we have therefore a slight overweight on the long-end part of the curve. Similarly, we also favour long-end parts of the French and Belgian curves, which are offering a bigger pick-up relative than the German curve.

More prudent on EMU non-core rates

Conversely, the recent risk aversion prompted us to be more cautious towards the non-core sovereign area. The global growth slowdown will impact euro-zone economies, despite a resilient domestic demand and lower jobless rate. January PMI lost some ground (down to 53.6 from 54.3), with Italy leading the way (Chart 2). As a result, we expect a more modest recovery. After Spain & Portugal – mostly for political reasons – we took profit on our long Ireland. We remain overweight Italy as, compared to peers, political risk is much more limited.

Long New Zealand rates and Norway

We think the Reserve Bank of New Zealand is ready to ease its policy in the near term to face downward growth and inflation pressures. Indeed, the country is entering into recession and the central bank has room to further cut its cash rates (2.50%). According to our calculation of the Taylor rule for different countries, the central bank rate is too high (Chart 3). As a major oil exporter, Norway should also face significant short-term headwinds that will incite its central bank to develop a more accommodative monetary language. We are thus maintaining our diversification towards these AAA-rated sovereign bonds offering attractive yield pick-up (respectively 3.05% and 1.37% for the 10-year segment).

CURRENCY STRATEGY

Long JPY & short NZD

We like Yen, despite the recent economic slowdown. Our long-term signals indicate that the JPY is in attractive territory (partly due to a cheap Purchase Power Parity valuation). Although investors are deeply short the currency, the trend is reversing, giving it an important rebound potential. Also, the JPY conveys a safe-haven status in a risk-off context. Lastly, the BoJ remains confident that its easing programme will be sufficient to boost inflation towards its 2% target.

We are negative on the New Zealand dollar. The softness of the business cycle in China will continue to pressure currencies of major business partners. Further, the fall in commodity prices is weakening the currency. And, as explained earlier, the central bank has room to ease its monetary policy.

Tactically opportunistic on EM Forex

EM currencies have undergone significant corrections, with a cumulative decline above 50% since 2010. Currencies of commodity-exporting countries suffered the most, with the temporary fall of oil prices to below 30$ a barrel. At these levels, we consider that very few EM currencies currently screen expensive. The recent improvement in risk sentiment, with peaking inflation and growth data resilience, have prompted us to be tactically more positive on EM currencies.

In particular, we tactically turned positive on currencies of oil exporters – the RUB, the MYR, the MXN, the COP – on the view that oil stabilization is likely around current levels. More strategically, we favour the INR, which is benefiting from the improvement in investor sentiment on the back of good reform momentum and lower external sector imbalances. We also like many Eastern European currencies such as the HUF, the PLN and the RON, given the good mix of growth and inflation and expectations that European crossover investor demand will remain high. It is, however, difficult to see a clear turnaround, as Chinese and commodity risks have not yet dissipated. That is why our changes of positioning remain tactical for the time being and we are maintaining a cautious stance for many other currencies.

One of our biggest underweights is the BRL, with high political risks slowing down the required structural reforms. We remain negative on many Asian currencies (e.g., the MYR, the THB). Most Asian central banks have space to ease, and this could exert pressure on currencies. The hard landing of China is also penalising its neighbours, who are closely economically linked to China. We remain underweight CNY as we expect FX regime liberalization and slowing growth to usher in further currency weakness.