Transcription

• Disclaimer

  This podcast is only for the attention of professional investors in the financial industry. Outerblue by Amundi. Welcome to Outerblue Convictions, Market Analysis and Asset Allocation Views.

• Swaha Pattanaik

  Hello and welcome to this Amundi podcast on our views on the latest moves in macro and markets. I'm Swaha Pattanaik, the Head of Publishing and Digital Strategy at the Amundi Investment Institute. And it's my pleasure to welcome Monica Defend, who heads up the whole of the Institute. Hello, Monica. Welcome and thanks for joining us.

• Monica Defend

  Thank you, Swaha. It's my pleasure.

• Swaha Pattanaik

  So I started off, Monika, by saying we're going to discuss the latest moves in macro and markets. That might be a little bit of a stretch given the warp speed at which macro markets and geopolitics are moving. Can I just start off by asking you how are you and your teams keeping up with what's going on and how are you thinking about the convictions that you have on markets, asset classes, portfolio allocation.

• Monica Defend

  Yes well actually if I think of the life our head of geopolitics is having it's awful because to keep the pace it means she cannot sleep and she has to follow it 24 hours seven days a week so for us we will have a deal when we will have a deal. We are not looking at escalation, de-escalation. What we decided eventually was to centre all the outlook, view of the world and expectations on the financial markets on the Hormuz Strait and when it will open. This is for us is the key assumption. And for now, we have the expectation that somehow it will open. starting from end of June and progressively normalizing. If this does not happen, then materially, we will have to change our economic assumption because the probability of a recession and a global recession might definitely be higher.

• Swaha Pattanaik

  Thank you, Monica. That sounds like a much saner way of looking at things rather than trying to keep up with every nano move. What has, however, been happening, and markets will look at every nano move, is there's a lot of volatility in global bond markets, and we've seen a very significant jump in yields. I presume some of what you're talking about has been driving these moves, but could you perhaps give us a little bit more flesh and bones of why we've been seeing it?

• Monica Defend

  Yeah, sure. And again, I think the Hormuz Strait remain central because it implies not only that the energy shock is more persistent, but is broader and will affect food prices, fertilizers, and this eventually will have an impact on inflation. So, the short end of the curve has been repricing the central bank's forward guidance with the ECB and the Bank of England being more hawkish than what we expected one month ago. At the point that actually we revised and we now expect 1-2 hike, hikes by the ECB and one hike by the Bank of England, while on the Federal Reserve we keep an extended on-hold period until the second quarter 2027. So, the markets have been repricing these moves and this has been reflected in the front end with less clean action, if you want. On the long end, again, this has been reprising that all these new geopolitical environment in what we call a low trust world will come with more fiscal spending. And this will drift the rates higher. Then you need to distinguish what happened in the United States where part of the movement was largely explained by an increase in real rates, with what happened in the UK and in the euro area, where part of the increase was largely explained by break-even. So there are different engines to the rates increase.

• Swaha Pattanaik

  Thanks, Monica. I mean, it sounds like the yields are going up across the board, across all tenors. You and your team have been calling, Amundi has been calling for, steeper yield curves. Where does that leave the call on the yield curve now?

• Monica Defend

  Well, probably on a tactical horizon, as I was saying, this is less clean. But given, for example, that in Europe we are pricing in 1-2 hikes, that is less than what the market is pricing, we're not going to change our strategy with the idea that in the long end you will have higher rates, with probably in the short term a less clean movement on the front end of the curve. But the steepening remains one of our preferred medium-term calls and convictions.

• Swaha Pattanaik

  Good to know. So, I mean, generally when yields rise, at some point they get interesting to buy into. What could be some of the entry points? Where are these entry points that you see? Have you already seen yields at levels that you think are interesting, appealing, or is credit appealing? Where would you go?

• Monica Defend

  Well, we still remain convinced that there won't be a clear directionality into yields. And there are, for example, if you take into account the 10 years in the United states. We are convinced that 4.5 is the comfort zone for the US administration, but probably in relative terms is what the equity market would like to see moving above, could be less appealing for being invested in the equity market, but we can discuss about this later on. So, and we are really focusing on the volatility. Probably it is even more important than the levels of rate at this stage. Honestly, we maintain an interest in the shape of the curve. So, in the United States, still the preference for the two 30 years maturity with less conviction than last month. And by the way, we prefer linkers in the region, while on the Euro curve, still the two five years is attractive and we are wary of the long end. Probably duration wise, we have a positive bias in Europe while we are not convinced to take a position on the US treasury market and we maintain some position on peripheral. Again, it's very diversified, the fixed income exposure, because it's not clean, the direction of travel.

• Swaha Pattanaik

  So a lot of digging down the detail sectors, you know, specifics of countries, absolutely. You mentioned equities. Let's touch on that. I mean, to quote a very well-known British film, not sure how well known it is anywhere else, equity markets seem to be able to look on the bright side of life and whistle whatever's going on and whatever's being thrown at them. So how long do you think this resilience can go on for some of it's AI driven, but there's also other things going on?

• Monica Defend

  The key question I'm getting from our clients is, but to what extent in relative value the equity rally can continue? Is there a level you have in mind? So what we did was to disentangle the interest rate impact on equity fundamentals, interest rates, cost margins and valuation. So, what we are seeing on the multiples, what we are seeing on the multiple side is that maybe a further increase of 20, 30 basis points could really create a correction in the market but is the movement of the curve that I was mentioning before that will be more more relevant to the extreme of bear flattening which will be the worst for the equity market and the better than anything else a bull steepening. But if I have to square it in terms of delta changes in the 10 years for the same amount of a 10-year interest rate, the impact would be more severe if the two-year tenures increases above 30 basis points and much less if the increase of the two years is in between zero and 29 basis points. So, this is why it's the movement of the curve that is more relevant from a multiple perspective. If we look at the fundamentals, interest rate cost on average ex-financial is very well below the historical average, but we should not underestimate the impact of developments in the future, because post-pandemic the corporate sector has been working a lot on the restructuring of their debt exposure, but it goes without saying that debt service ratio will increase. So also in the case of a Fed that will reduce interest rates and again our base case is for a protractted and extended on hold, definitely in the future the debt service cost will increase. So we might see a damage on that front. But for now it is manageable.

• Swaha Pattanaik

  Thanks, Monica. So we've been talking about global bond markets and big themes that are across fixed income. Let me turn a little bit more specific to the UK. You mentioned it earlier. So I'm sitting in London, you're sitting in Milan. I see a lot of commentators here in the UK talking about sort of the Italianization, if you like, of the UK politics, UK public finance. I should ask you, how does it look from across the way, where you're sitting, do you see parallels? Because from here, Italy seems like a bit of a pole of stability with not cycling through prime ministers every couple of months. And they are trusted by the bond markets, given the spreads. So what are the parallels? Where is this falling short, perhaps, as an analogy?

• Monica Defend

  Well, honestly, given my seasoned profile, I've seen a lot of volatility, until almost four years, and it's quite surprising, and it's a positive surprise, we got this stabilization that has been reflected, for example, in the spread level. And in the past, much of the spread level was really related to the volatility on the instability at the government level. Today, when I look at the UK market, I think that part might be related to this volatility on the political page, but there is also a fundamental reason because we have weak growth and tighter financial conditions, we have inflation and this eventually could put a material threshold, a material cap to the level real yields in the UK rates. The constraint is credibility as always and probably this is where how we might make some parallel with Italy. But when you have inflation that is still sticky, the service costs that is this rising and fiscal choices that are politically difficult. Again this might be the analogy as an investor in Italian PTPs in the past and today by the way and in the UK demand a higher term premium unless I see a really clear and durable anchor. Hope this answers your question.

• Swaha Pattanaik

  Absolutely, it does. That's both the differences and the similarities, perhaps with the past and with the path that the UK government may need to take to arrive at narrower spreads, as you're saying, with the credibility, the control of inflation, taking some difficult choices. None of that seems easy to do in the current political and economic climate. Monica, thank you, as always, for joining us and for spanning such a range of subjects. Great to have you on the podcast as usual.

• Monica Defend

  Thank you Swaha thank you so much.

• Swaha Pattanaik

  And thanks to all of you for tuning in. Join us next time for another Amundi deep dive into research and macro markets.

• Disclaimer

  2014-65-EU, dated 15 May 2014, as amended from time to time on markets and financial instruments, called MIFID II. Views are those of the author and not necessarily Amundi Asset Management SAF. They are subject to change and should not be relied upon as investment advice, as a security recommendation, or as an indication of trading for any Amundi products or any other security, fund units, or services. Past performance is not a guarantee or indicative of future results.