In this interview we assess how our views have evolved in the first half of 2015 and look ahead to the second half. ‘Marking our views to market’ is an important exercise in reviewing whether or not the trends we believed would drive financial markets in 2015 have in fact played the role we anticipated at the end of 2014, or not.
This interview was conducted on 22 June 2015.
To start with the outlook for economic growth in the world, what have been the surprises so far in 2015?
It’s clear that the US economy has disappointed relative to our expectations, but we do not think this will last. The jump in the household savings rate looks overdone, so this money could well be spent in the months ahead. The labour market has rebounded and become more dynamic. The negative inventory cycle should end soon. Since this is a relatively closed economy, the stronger dollar should not hurt exporters that much. We may have to wait for the second half for above-trend growth to become visible.
The recovery in the eurozone has played out more or less as we thought. Consumer spending has been stronger than we expected, but investment spending has yet to recover. This makes us slightly cautious. Low oil prices and a depreciated euro still provide tailwinds, albeit with less force.
Japan is muddling along with what looks like a disappointing recovery, just as we expected late last year. The slowdown in China and the recessions in Brazil and Russia are more pronounced and may last some time. This has held back growth in other emerging economies.
Have these developments changed your view on monetary policy?
Not so much for the US. We think the Federal Reserve’s first rate hike in this cycle is likely to be in September. Regarding European Central Bank (ECB) policy, inflation has stopped falling and inflation expectations have backed up, but unemployment is decreasing only moderately and remains high, so the disinflationary pressures have not fully abated. Monetary easing will continue for now.
We see more monetary easing generally in Asia, although more policy easing by the Bank of Japan has become less likely. In China, we do expect more easing, even though the pace of rate cuts and reductions in bank reserve requirements may slow. Other candidates for rate cuts include India, South Korea and Indonesia. Brazil is an outlier in this world of very easy monetary policy, but we do expect the tightening cycle to end soon and even to reverse.
What about recent developments in bond markets?
Given the outlook for growth and inflation, the upward pressure on yields appears excessive. That said, in the eurozone, scarcity fears might resurface amid the ECB’s asset purchase programme. Add to this the uncertainty about the timing of the US rate hike and further volatility looks likely.
What is your asset allocation for the second half of 2015?
In equity markets, we have seen increased nervousness. We have closed our equity overweight and moved to a neutral stance. We took profits on our overweight in European real estate after a good run, even though this trade did not add much risk to our portfolio.
We took profits on our overweight in Japanese equities versus Europe. We prefer Asia over emerging equities generally. We like European small caps, which are not cheap, but should benefit from the European recovery, while lacklustre emerging market growth may hold back large caps.
We like high-yield corporate bonds, which we overweight against short-dated government bonds in Europe and against commodities in the US.
We have now moved to a long duration position in core eurozone government bonds. This is partly driven by a changing supply and demand balance: over the summer, new bond issuance looks set to become limited, while the ECB has said it will frontload its asset purchases before the mid-year drop in market liquidity. The position is a hedge against any adverse outcome of the situation in Greece.
We are short the euro versus the US dollar as we expect the dollar to resume its upward trend.
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