In February, developed equity markets recovered. Lower-than-expected inflation data kept bond yields low. While our equity overweight paid off, our short duration position in fixed income disappointed. On account of the rising geopolitical tensions we have closed our overweight position in emerging market hard currency debt.
Recent weak US economic data is seen as being a consequence of the severe winter weather. Is this also your view?
Yes, we do believe that the exceptionally harsh winter in the US has had a strong negative impact on most US economic data recently, and recent market behaviour suggests that most investors agree with this analysis. We are mindful that we could be overestimating the impact of the cold winter as regional data shows weakness in areas not affected by the weather. Retail sales were already slowing before the weather turned extreme. Nonetheless, although the first quarter is shaping up to be quite weak, we expect growth to improve. For 2014 as a whole, we foresee stronger growth than in 2013, but still barely above the US’s potential growth rate. We expect the Fed to maintain its policy of lowering asset purchases.
We are increasingly seeing signs of a two-speed recovery: faster economic growth in developed economies than in emerging markets. Do you think this will continue?
Eurozone growth accelerated in the last quarter of 2013. At +0.3% relative to the final quarter of 2012, it was not particularly strong, but faster than in the third quarter. German growth was steady at 0.3%, while growth improved in France, Italy, the Netherlands, Belgium, Spain and Portugal. The eurozone’s composite PMI weakened, but the Economic Sentiment Index and Germany’s Ifo index rose further. Structural improvements have brightened the outlook for some ‘peripheral’ countries. Spanish government bonds were upgraded by one of the main rating agencies and the return of Ireland and Portugal to capital markets was met by a healthy demand for their new issuance. Growth in the eurozone will be lower than in the US this year, but we think it has more potential for a surprise to the upside. Persistently low inflation could be worrying the ECB, but with improving growth, we foresee only small reflationary policy steps, if any.
In contrast, growth in emerging economies has generally slowed, but given the becalmed foreign exchange markets, we do not expect a severe slowdown. GDP data for the fourth quarter and PMIs for February (as far as available) were mixed. Having said this, we see two main concerns. China’s manufacturing PMIs fell further in February, stoking market worries about an uncontrollable slowdown. We do not expect this to happen, with no real economy or monetary indicators to suggest an imminent dramatic slowdown. Risks to the downside include the boom in credit in recent years. Political unrest could also cause upset, notably in Ukraine.
Do you think the developments in Ukraine will have a lasting impact on markets?
While the Ukrainian economy itself is small, a large-scale conflict could threaten Russian gas supplies to Europe. Due to the turmoil in Ukraine, we closed our overweight in emerging market hard currency debt. Civil unrest could hurt market sentiment: investors might begin to scrutinise and overreact to issues in restive countries such as Venezuela and Thailand. Impressed by the market’s resilience, we’ve maintained our overweight in developed market equities. Last month, what we considered to be an excessive fall in US and German bond yields led us to implement a short duration position in German sovereign debt. Yields however have fallen further, driven by safe-haven flows provoked by political unrest in emerging economies. We continue to think bond yields are too low given the improving economic environment and the fact that any stimulative ECB measures are fully discounted.
 Source for all data: Bloomberg or Datastream, unless otherwise specified.