The official blog of BNP Paribas Asset Management

Weekly investment update – A green swan!

As economies continue to reopen, stronger economic data bears witness to the strength of the cyclical recovery. Signs of rising inflation globally have not roiled bond markets excessively. The message from central banks on rising inflation being transitory in nature is, so far, holding the line.

Covid-19 – new case numbers fall

Globally, the number of new Covid cases has continued to fall. Global new case numbers have now dropped to below 500 000 per day, while new cases in India have fallen further to less than 150 000 per day.

Transmission in Latin America is a concern as infection rates remain high. Advanced economies continue to experience broad-based declines in infection rates as vaccine coverage expands.

Evidence points to only a mild reduction in the efficacy of vaccines against the Indian variant in the UK, calming fears of new variants pushing the economic reopening off course, for now.

US bond markets on hold

The minutes of the April meeting of the US Federal Open Market Committee published earlier this month revealed a larger than expected constituency of monetary policymakers favouring moving forward with the process of tapering central bank quantitative easing (QE) ‘sooner rather than later’.

In response, US nominal bond yields rose to their highest since the start of April. Since then, they have fallen, ending May at around 1.59%.

The minutes highlighted that ‘a number of participants’ felt that if the US economy continued to recover “it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of [QE] asset purchases.” The more hawkish participants highlighted that “supply chain bottlenecks and input shortages may not be resolved quickly and, if so, these factors could put upward pressure on prices beyond this year.”

Since then, speeches by several Fed governors have been on the dovish side, pointing to the inflationary effects of the recovery as being temporary despite further upside surprises on producer prices and the personal consumption expenditure (PCE) price index (up 3.1% year-on-year excluding food and energy after 1.9% in March).

Surveys in the US of business sentiment have continued to reflect expectations of an acceleration in the pace of activity in June, but markets are now focusing more on when a deceleration will occur.

Nonetheless, markets continue to price a more aggressive rise in central bank policy rates than the guidance provided by the Fed in its ‘dot plot’ has indicated. For the time being, markets are marking a pause ahead of the June 4 employment report and the Fed’s policy meeting on 16 June.

European catch-up underway

Earlier in May, eurozone composite purchasing managers’ indices PMIs exceeded the consensus forecast, suggesting the recovery is well underway during the second quarter and boding well for a rebound in survey indicators in the months ahead.

There should be further room to run as vaccination campaigns are allowing economies to carry on reopening. As a result, something of a European catch-up is very much on track. It cannot be excluded that the improving outlook will allow the European Central Bank (ECB) to take the foot off the monetary gas pedal in June.

However, price pressures have continued to mount at a heady pace in the eurozone, driven by growing supply-demand imbalances. Data published on 28 May showed the eurozone’s harmonised index of consumer prices (HICP) rose by 2% in May, up from 1.6% in April. Supply chain disruptions, including difficulties in re-hiring, are persistent throughout the eurozone, reflecting the imbalances.

The ECB’s governing council meets next week to decide whether to adjust monetary policy — including its recently accelerated pace of bond buying — in response to signs that economic activity and prices are rising as Covid-19 lockdown measures are eased.

Several policymakers, including President Christine Lagarde, have insisted, however, that the recent surge in inflation is only a temporary phenomenon, driven by one-off effects. They predict it will fade next year. A 13.1% year-on-year rise in eurozone energy prices was the main factor driving up the HICP to its highest since October 2018. Core inflation, excluding the more volatile prices of energy, food, alcohol and tobacco, rose more modestly than the headline figure, from 0.7 % in April to 0.9% in May (see exhibit 1).

Green bonds and a green swan

Green bond issuance is growing rapidly in 2021. With nearly USD 200 billion issued thus far, it is quite possible that total issuance this year will reach between USD 430 billion and USD 460 billion, given that several of the typically larger issuance months are yet to come.

Sustainability-linked bonds (SLB) have also doubled in issuance this year, with growth forecast to rise in 2021 to between USD 80 billion and USD 110 billion.

Today sees the start of ‘Green Swan 2021 – Coordinating finance on climate’ – an unprecedented conference for central bankers. The virtual meeting is co-sponsored by the Bank for International Settlements, the Bank of France, the International Monetary Fund and the Network for Greening the Financial System (NGFS). The topic: "How in practice can the financial sector take immediate action against climate change-related risks?"

The clear message from the NGFS is that climate-related risks are part of financial risks. As such, they are not optional extras for financial institutions and supervisors. They are part of sound risk management. Climate-related risk constitutes an essential part of the first duty of a financial institution and a regulator — a duty to financial stability.

This autumn, the ECB is scheduled to publish a review on decarbonising its balance sheet and tilting asset purchases away from the most carbon-intensive assets. Current discussions envisage three tools:

  1. Modelling The ECB is working on improving its analysis of the economic effects of climate change. It published its first scenarios in June 2020, and will update them each year (starting next week).
  2. Disclosure The ECB intends to disclose its climate-related risks, and to impose disclosure on counterparties, which should have a powerful exemplarity effect.
  3. Operations The ECB is considering incorporating climate-related risk in the assessment of both its collateral and asset purchases, focused on corporations. Data on climate alignment could be used to progressively develop the ECB’s policy on asset purchases of corporate debt and its collateral policy.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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