Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Will European policy makers pull out the bazooka tomorrow?
Peter Garnry
Chief Investment Strategist
Summary: European equities are down 22% from the peak and investors are preparing for more lockdowns and thus are cutting risk exposure. The pressure is on the ECB and EU to deliver a coordinated stimulus response to offset the weakness from the COVID-19 and future lockdowns similar to the one currently in Italy. Equity markets could easily see a short-lived rebound tomorrow on the likely policy response in Europe and thus we are again flagging our 'bounce back basket'.
Global equities are weak today despite a 50 bps rate cut from BOE, heavily expected in money markets, and reassuring but cheap words from Angela Merkel that Germany will do ‘whatever is necessary’ to face crisis from coronavirus. Sentiment is weak and investors are still cutting risk exposure as it looks inevitable that more national lockdowns will follow after Italy crumbling demand in the US and Europe. The STOXX 600 Index is up 0.6% today but still down 22% from the peak. With the VIX Index remaining above 50 our view is that volatility will stay high and future returns will be skewed to the downside. Global high yield credit bonds are seeing terrible liquidity and despite the rebound in oil prices high yield energy bonds are selling off in a sign of market stress. As we have been saying for a while the real threat, which ECB President Lagard acknowledged today, is that this turns into a credit crisis that definitely will force European policy makers to bail out more weak European banks.
The EU and ECB have overall been quiet regarding COVID-19 and anticipation is building for tomorrow’s ECB meeting. With Lagarde’s comments to the press today it’s likely that some coordinated stimulus package could be announced infusing equity markets with short-term confidence and a rebound. But already on Friday the selling pressure could come back as investors will most likely cut risk into the weekend. This market is in a tug-of-war between reality and economic impact from COVID-19 and policy makers trying to respond with a lag. At point into the future there is an equilibrium between those two forces and when we reach that point the equity market will bottom and investors will have to aggressively jump the rebound.
Our ‘bounce back basket’ (see the list in SaxoTraderGO) announced on Monday is still up 1.2% in local currency since Monday’s close which is better for now than the European equity market down 0.7% measured on the STOXX 600 Index. The two worst performing stocks are Inditex and Adidas which obviously are hurting from changing consumer behaviour on main street. Today Adidas announced that they expect a €800mn to €1bn hit to revenue in Q1 from China which is little less 5% of overall revenue. Adidas’ overall expectation globally is 10% decline in revenue in Q1. This is before impact from Europe and the US which will come as regions will follow Italy and be quarantined. Inditex is weak for now as their e-commerce size of overall revenue makes it vulnerable on relative basis to fashion retailers such as Zalando which doesn’t rely on physical stores to drive revenue.
As we wrote in our equity update ‘Lessons from 2008 on how to navigate equities in high volatility’ we will publish later today mean-reversion watchlists on US and European equities. These will provide clients and investors in general with inspiration for tactically navigating the daily volatility in global equity markets.
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