Mid Monthly Update – September 2019

Whatever it takes – Draghing the Euro down – even lower for longer
August’s mid-monthly update was titled ‘Lower for Longer’, referring to the extremely low, often negative yields available on longer-dated maturities in the bond markets of North America, Europe and Japan.  On September 12th, the European Central Bank (ECB), as anticipated, lowered its deposit rate to minus 0.50% from minus 0.40% – yes, really.  What’s the point I hear you ask.  Isn’t this like pushing on a string?  Yes, it is.
Additionally, as ECB chief, Mario Draghi prepares to hand over the reigns of the ECB to Christine Lagarde in November, the ECB re-started quantitative easing (QE) to the tune of €20billion a month starting in November for ‘as long as necessary’.  €20billion a month will likely be enough to hoover up all the expected net European government bond issuance in 2020, probably as a consequence, keeping a lot of government debt in negative yield territory.  Italian yields declined the most of the European government bonds as the ECB will probably end up owning even more Italian debt.  Draghi also helped European banks by introducing a two-tier deposit rate system for reserves thus breathing oxygen into quasi-zombie banks.  For those that think this is all a bit déjà vu, Japan went down this road for over twenty years without success as we discussed in our blog ‘Turning Japanese’ in February this year –
At the regular post-ECB meeting press conference, Draghi denied that the ECB used the € as policy tool; not everyone thinks that is true.  QE and the level of € official rates should support a weaker € and in the process prod US President Trump into a response possibly accusing Europe and in particular, Germany with the largest current account surplus in the world at 8% of national output (GDP), of manipulating its currency lower in order to sell more cars.  Of course, one of Europe’s and Germany’s key issues is it makes things that people are needing less of, e.g. cars.
Internal Combustion Engine
Coming to the end of his term as ECB President, Draghi is essentially saying that monetary policy has reached its limits and, by re-starting QE, he has kept a lid on interest rate costs for governments and other borrowers.  This gives the Euro governments an opportunity to provide a fiscal stimulus – much needed as we have often referred to previously.
Are developed government bond yields the tulips of 2019?
Government bond yields in developed economies have risen over the past two weeks possibly as a consequence of some realism that a global economic slowdown isn’t a global recession.  Yet they still offer little value as an investment.  While the ECB’s recent move may prevent a significant rise in yields, government bond yields in places like the UK defy conventional logic considering whoever wins an election is likely to borrow more.
Don’t Panic
We believe we have seen panic buying of government debt as a safe haven in the face of global economic fears; to have some US$17trillion worth of outstanding government debt with a negative yield, smacks of bubble territory seen previously in history such as the aforementioned tulips.  While the ECB’s monetary policy may attempt to export some deflationary influences to the rest of the world, potentially aided by some new Trump tariff cards being played on the road that is his re-election campaign, bonds are generally not a viable investment asset class for those seeking to preserve their wealth in real terms.
Your Money
We have not altered the mix of either fund so far in September.  As Sterling-based investors, we are keeping a close eye on GBP exposure and are mindful of avoiding too much currency risk.  We believe a lot of bad news is priced into the UK’s currency which is as vulnerable to a spike upwards as it is on the downside, perhaps more so.
As always, we greatly appreciate your support.

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