Following the surprise victories of Brexit, Donald Trump in the US, and the candidacy of Marine Le Pen in France, investors are getting concerned with the future of the single-currency.
A clear reflection of this is the surprise sell-off of European bonds over the course of 2016 by foreign investors.
According to data presented by the European Central Bank (ECB), in 2016 the Eurozone had a record outflow: in total this past year, foreign bondholders reduced their stake in Eurozone debt by €192bn.
This represents the biggest retreat from Eurozone debt since the single currency was implemented in 1999.
In its annual report, the ECB mentioned a “heightened risk aversion” among investors towards euro-denominated debt following the surprise triumph of Brexit. The selling “may be linked to the temporary increases seen in financial stress indicators following the United Kingdom’s referendum on EU membership in June 2016”, the Central Bank said.
A multi-asset allocation expert that spoke with Bonds and Loans explained that, worldwide, “investors are assessing the macro shifts in the global economy; They are reassessing growth perspectives in Europe and potential for new fiscal policies in the US.”
He adds that, while most investors in European markets are local investors - like insurances companies and pensions funds - which binds them to the markets, foreign investors might view populism as a possible “threat.”
This is why we are witnessing a widening of spreads, not only between France and Germany’s sovereign bonds in the run-up to the French election, but even between corporates - depending in the country they are based in.
Philippe Ferreira, Global strategist at Société Générale, however, thinks the term “sell-off” is a bit excessive, he prefers “moderate losses”.
“The downward dynamic in European bond prices is essentially related to improving economic prospects, the normalization of inflation rates and the rise in Treasury yields in the US. In France, however, there is also a political risk component attached to it,” Ferreira explained.
Besides, the low yields on European bond have driven away investors that are looking to shift to other asset classes and markets in pursuit of better returns.
“Investors have favoured equities versus fixed income over the recent months, to get exposure to the improving economic environment and rising corporate earnings,” Ferreira added.
Breaking With “Populist Habit”
Even if this is not good news for Europe, it might represent attractive opportunities for emerging economies.
In a recent interview with the Financial Times, Michael Hasenstab, Executive Vice President, Chief Investment Officer, Global Bonds of Franklin Templeton Advisers, explained that his firm was dropping most of their stake in European bonds and hedging on Latin American securities instead.
Hasenstab mentioned the unpredictable political environment and the rise of populism in Europe as their main motive. He also praised Latin American countries, noting they were finally breaking their “populist habit”.
And he is not the only one; in 2017, the MSCI Index surged 7.4%, pushing the total of emerging market debt to a record US$1.95tn.
Of this most of the debt issued since last year comes from three countries: Mexico, China and South Korea. That is regardless of the fact that both Mexico and China are still the countries most exposed to Donald Trump protectionist agenda.
For Thomas Christiansen, Lead PM for External EMD at Nordea Asset Management, the positive performance of EMD has more to do with what is happening in the EM countries themselves, rather than what it is going on in Europe.
“One of the main reasons why EMs have seen positive inflows this year is that the fundamentals have improved; growth for many emerging countries in 2017 is much better than in 2016.”
“Countries in the developing world, especially in Latin America, have inflation rates near their targets and have been able to cut rates. They also have managed to improve their current accounts,” Christiansen said.
He added that the “difference” in growth rates between developed countries and developing countries is increasing again for the first time in a few years, as many Latin American economies are set to expand at much higher pace than Europe, which make them more attractive to foreign investors.
Christiansen noted that investors are not necessarily looking into EMs because of a riskier political panorama in Europe, but because many countries in the developing world, especially in Latin America, have more stable outlooks themselves.
“The EMs themselves are not actively taking advantage of the situation in Europe, but, indeed, the yields in some EMs have declined both in local markets as well as in their dollar-denominated debt.”
“I wouldn’t say the positive performance of EMs is a result of the political turmoil in Europe, but rather because of positive fundamentals and lower rates,” he concluded.
So far, it seems, 2017 is quite an erratic year for the markets, both in the developed and emerging world, as the traditional “safe havens” for investors are becoming riskier; the second half of the year may well reflect this latest shift in sentiment.
