Given the scale and importance of recent monetary policy measures and pronouncements from the main central banks, no significant changes are anticipated at upcoming meetings or during the spring/early summer. Janet Yellen has indicated the Federal Open Market Committee will retain a dovish stance and be prepared to take risks with inflation overshooting its target to secure its dual mandate. Both the European Central Bank’s Mario Draghi and Bank of Japan’s Haruhiko Kuroda remain committed to further action to drive inflation higher if needed, with the latter possibly adding to monetary stimulus in July.
The Bank of England’s Mark Carney has his hands full with the problems presented by the EU referendum given growing short term economic uncertainty and a rapidly depreciating currency. The governor described the vote as being the biggest domestic threat to Britain’s financial stability.
Bonds Rally Despite Back-drop
Somewhat surprisingly, all fixed income markets, including government bonds, rallied through March and into early April. With government yields already at such low levels, most 10-year real yields are now negative, global growth expected to reaccelerate over the next few quarters and the main central banks all committed to boosting growth and inflation, investors are betting heavily they will not succeed.
But then the fate of bond yields has long been determined by central bank policy rather than fundamental “fair value” models. Even so, the more positive macro background suggests that governments’ rally has come to an end and flat/negative returns are in store.
For corporate bonds, there is still scope for credit spreads to narrow, albeit the stage of the credit cycle suggests recent lows are out of reach even with reasonably favourable credit metrics. This should allow modest positive returns from investment grade and particularly high risk credit where US gains could exceed 5%. Emerging market debt offers similarly high return possibilities with corporates and local governments also in focus alongside hard currency sovereign debt.
Which Stock Markets Look Good for Q2?
Early-April witnessed some modest profit-taking in global equity markets but with little to suggest anything more serious is in store given an improving macro-economic background and central banks as supportive as possible. The best near term geographic opportunities appear in Japan and in Europe excluding the UK, generated by substantial prior underperformance and a mixture of decent valuation and expected improving newsflow over the next three to six months.
Without any increase in earnings forecasts US indices have rerated towards expensive levels once again, while the UK is likely to remain relatively friendless until after the EU referendum. Emerging look more attractive than developed markets with Asia particularly well positioned. Developed market upside is likely to be restrained by the US and in a low income world income remains favoured.
