Weekly View- Three to tango
After 16 years under the leadership of Angela Merkel, Germans went to the polls yesterday to choose their next government. Merkel’s party alliance, the centre-right CDU/CSU, suffered losses and the centre-left Social Democrats came out ahead. Importantly for markets, a leftist coalition was avoided and as of this morning, a “traffic light coalition” consisting of the SPD, Greens and Liberals, appears to be the most likely outcome. Meanwhile, German economic growth is fading, as it is in the rest of Europe. German bond yields have moved up, although they appear set to remain in negative territory for now. Last week’s European PMI prints disappointed on ongoing supply issues although demand remains strong. With these supply disruptions dragging on without any indication of imminent resolution, we are keeping short duration in our fixed-income exposure.
The world’s most-indebted property developer, Evergrande, continues to unsettle Chinese bond and equities investors as local governments seize the company’s revenues and new debt deadlines loom. While the Chinese authorities continue to seek solutions for the highly leveraged developer, Evergrande investors are still waiting for a USD84 mn offshore coupon payment due last Thursday. Any eventual solution will benefit exposed subcontractors and apartment buyers, but at the expense of the company’s bond and equity holders. We are underweight Chinese equities. Elsewhere in the world’s second-largest economy, to discourage crypto-trading speculation, last Friday the Chinese government announced that all crypto-related transactions are now illegal. Given current dynamics, we remain positive on Chinese government bonds for now.
Central bank meetings around the world last week set a generally hawkish tone. The Federal Reserve’s latest dot plot left markets believing that the first Fed funds rate hike could come as soon as the end of 2022, while Norway’s Norges Bank became the first G10 central bank to raise rates amidst rebounding economic growth and mounting financial imbalances. Brazil’s central bank raised rates by 100 basis points (bps) on continued inflationary pressures - its fifth rate rise this year. In contrast, Turkey cut its benchmark rate by 100 bps to encourage faster growth amidst soaring inflation. We are underweight emerging markets. Last week’s European economic indicators and slowing US housing data also make us cautious, as any turn in major central banks’ monetary policies will be complicated, especially if tapering is concluded rapidly, as it seems it will be.