The interest rate environment and the bond market situation in general remain challenging, particularly given that, contrary to popular belief, the corporate default ratio is on the increase, notably in the US. The ratio has risen from 1.43% in 2014, in the high-yield category, to 2.75% in 2015 and 3.64% year-on-year at 30 June 2016. The defaults are concentrated in the oil and gas industry, however, and the price of crude has rallied sharply from its lows. The low level of US oil reserves and the possible agreement between Russia and Saudi Arabia are also likely to support the more bullish trend. The high-yield segment in general in the US, like in Europe, may be hit by upward pressure in interest rates. Faced with negligible bond yields, only the most catastrophic deflationary and recessionary scenarios can justify investors’ keen appetite for sovereign and corporate debt. However, monetary policies have surely now reached their limits. Moreover, the ECB acted as was required at its latest conference, i.e. it refrained from intervening.
On the other side of the Atlantic, US monetary policy is becoming increasingly untenable and the next rate hike is now close at hand. The dollar may strengthen in the medium term, even though it has not always automatically done so in the past in response to steeper rates.
The ECB will also find itself confronted with the rate-hike dilemma if inflation ever picks up again. The markets will be watching US employment data very closely, constantly looking for signs which may trigger the next rate rise. The difficulties encountered by the Fed in disengaging from a permissive over-accommodating monetary policy will serve as a lesson to Mario Draghi’s teams. Furthermore, the ECB will have to juggle between its role as central banker and eurozone integrator. Governance in the eurozone and the European Union is also generally more complex than in the dollar region. The two monetary policies should not therefore always be considered in exactly the same light.
Nevertheless, excessive divergence between the two monetary policies for too long a period would create distortion and a windfall effect among international financial markets. The banking sector would benefit most if these monetary policies were discontinued and the low interest-rate environment, which is depressing their profitability, comes to an end, particularly as European banks have doubled the level of regulatory capital held on their balance sheets. The sector has indeed returned a strong relative performance over the past few days, compared to European equity markets which have been caught in a bearish trend.
It is now up to governments to take over the running from the central banks, as households and companies are becoming increasingly wary of the political incertitude weighing on modern democracies.
Igor de Maack, Fund manager and spokesperson at DNCA. This article was finalised in September 9th, 2016.
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