Central Banks set priorities, jobs first, pensions later
Central Banks set priorities, jobs first, pensions later. Last week, Larry Fink (BlackRock) and Bill Gross (Pimco) emphasised the threat that negative interest rates policies (NIRP) pose to pension and insurance companies business models. Fink and Gross opine that negative interest rates would crowd out savers’ money from fixed income to cash. The IMF reacted by saying that the portfolio balance channel will just reallocate savers money from safe to risky assets. In March, inflows toward European high yield bonds and emerging markets have been the largest on record, €3.2bn and $9.09bn respectively, according to JP Morgan. But, part of these inflows are likely attributable to a rebound of oil prices in March (WTI oil price rose 13.6%).
If NIRP eventually endangers the business model of pension and insurance companies, we believe central banks can adapt in a similar way that the European Central Bank (ECB) has done with regard to European banks. The announcement of a new series of targeted longer-term refinancing operations (TLTRO II) by the ECB in March 2016 is one example of how central banks can be reactive to the threats NIRP can pose. Prior to TLTRO II, NIRP threatened European banks’ business models. The interest rate on the ECB deposit facility has been negative since June 2014, which means that European banks have been paying interests on their excess reserves held at the ECB. This led to the erosion of their profitability as they have been reluctant to pass through negative rates onto clients deposits. Starting in June, the TLTRO II will allow banks to borrow from the ECB at the same interest rate as they pay on the deposit facility (-0.4% as of 10 March 2016). In other words, the ECB will return the negative rates paid on excess reserves as a discount on funding, as long as loans are extended.
In our view, central banks will not abandon the NIRP until macro data shows clear signs of improvement such as substantial labour market performance, along with significant and sustainable inflation pressure. Evidently central banks have learnt from their past mistakes and are being proactive by finding solutions to counter non-desirable effects. If the threat to pension and insurance companies’ business models materialises in the euro area, one solution would be to allow the purchase of their bonds in the new ECB corporate bonds programme in order to compensate them for their asset/liabilities mismatch.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
The latest IMFs report highlights how important emerging markets are
The latest IMFs report highlights how important emerging markets are. Developments in emerging markets (EMs) account for more than a third of the variations in stock market and foreign exchange market returns worldwide, according to the IMF’s Global Financial Stability Report released last Monday. The financial spillovers – the extent to which EM equity returns are reflected in developed markets equity returns – have risen 28% (IMF estimates). For the largest emerging economies (Brazil, China, India, Russia and South Africa), they have risen by 40%. The spillovers on bond markets are less clear because bond flows have been strongly affected by monetary policies in advanced economies. (click to enlarge)
Why do EMs get so much attention today? It is because EMs are far more invested now than ever, with the financial crisis being a catalyst to investor diversification. EMs share of global equity market capitalization more than doubled in the last twenty years amid declining market segmentation. The growing trend in EM financial integration is likely to continue until reaching a level consistent with the extent of their contribution to the global economy. EMs contribute to 38% to the global GDP but represent only 13% of the global financial system, according to data compiled by the IMF.
EM’s role in the global financial system is likely to continue to grow at a steady pace along with EM’s share in investors’ portfolios. First, EMs have demonstrated financial and economic resilience despite financial turbulences. Second, the quantitative easing programmes from developed economies have accelerated their integration into the global financial system by pouring liquidity into EMs. We believe the unconventional central bank policies are not likely to terminate any time soon. When they eventually end, it most certainly will not be in an abrupt manner. For these reasons, we think EMs are becoming a permanent and an influential financial players. In our view, current credit spreads are overcompensating investors for the credit and liquidity risks.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Weekly Flows Analysis – The Fed minutes boost gold
Gold ETPs registered strong inflows after the release of the Federal Reserve (Fed) minutes of the March meeting on Wednesday suggested the chances of a rate hike in the short term were extremely limited.
The larger than expected draw on US crude oil inventory helped maintain flows into oil ETPs steady.
Inflows into broad commodity basket have risen to their highest level since December last year.
Inflows into broad baskets indicate a stronger interest from investors led by gold rebound and energy. Inflows into commodity baskets rose by their highest level since early December 2015 (US $27.3mn).
Precious metals benefited from the increased risk aversion following the release of the Fed’s minutes. Gold ETPs attracted larger inflows last week, US $118.6mn from US$96.8 the week before, as investors scaled back expectations for further rates hikes in the US. The minutes of the Fed’s March FOMC meeting released Wednesday showed officials seeing persistent external risks and the threats they posed to the US economy. As a result, the odds of a rate hike in December have dropped to 48 percent from 58 percent earlier last week, based on Fed-fund futures data. Market participants now expect policy makers’ next move in February 2017. The increase of risk aversion and the subsequent decline of the US dollar versus Japanese Yen and Euro, led to the gold rally last week. Silver ETP inflows also increased last weak reaching their 4 week high, marking seven consecutive weeks of increase.
Energy ETPs continue to attract strong inflows, led by Brent oil ETPs (US$17.6mn). Ahead of Doha meeting on April 17, oil prices advanced last week on speculation over whether an accord to freeze or cap output can be reached. Saudi Arabia said it will only agree to a freeze if other suppliers do so, while Kuwait said a deal can be done without Iran’s support. On the other hand, WTI crude oil ETPs received inflows worth US$15.3mn as US oil inventories were drawn down more than expected.
Copper ETPs attract US$10.8mn of inflows amid declining price. Inflows into copper reached US$10.8mn last week reflecting investors bargain hunting after copper has declined 4.4% last week to a six-week low of $4,630 per ton. In addition, aluminium ETPs inflows surged to their highest level in six months (US$12.7mn).
Key events to watch this week. Industrial production data in some of the world’s largest economies (US, Euro area and China) will give investors a gauge for how demand for commodities is faring. Additionally, markets participants will also be looking at retail sales and the Empire State survey of manufacturers in the US. Separately, inflation figures in the euro area, UK and US will also be of greatest interest for investors. The Bank of England will conduct its monetary policy meeting on Thursday. The decision is broadly expected by market participants to remain unchanged (i.e. total asset purchases of £375bn and base rate at 0.5%).
Video Presentation
Morgane Delledonne, Fixed Income Strategist at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
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