German ruling and ECB plan mark watershed for bond investors
Following today’s German Constitutional Court decision and last week’s ECB announcement, Russell Silberston, Head of Developed Rates & Currency in Investec’s Fixed Income & Currency team, explains how these developments mark a fundamental shift taking pla
Underlined by today’s Constitutional Court ruling in Germany, the unveiling of plans by the ECB for ‘unlimited intervention’ not only represents a defining moment but may carry with it ‘unintended consequences’, heralding a fundamental shift in bond investors’ mindsets, comments Russell Silberston, Head of Developed Rates & Currency in Investec’s Fixed Income & Currency team.
Commenting on today’s ruling, Silberston said, “The result was exactly in line with expectations. The tail risk of a negative decision would have been so significant that it would have essentially meant the end of the single currency, and the relief rally in markets continues for now.”
Form an investor perspective, he goes on to note that in a total shift away from their traditional characteristics, some government bond investments are now behaving in the same way as risky assets, leading the Investec Fixed Income and Currency team to look at Canadian, Swedish, and Norwegian government bond allocations as well as some EM regions as beneficiaries of this shift.
Unintended consequences
“’Unlimited intervention’ constitutes a very powerful tool, he says. “In terms of magnitude and firepower this is a major event, with a backstop from the Central Bank – not something that was in place previously.” He goes on to question the potential risks posed by the idea of ‘conditionality’, with the possibility of unintended consequences. Silberston notes, “The speech stated that when their objectives have been met – when monetary policy is working properly in the Eurozone – the ECB will terminate the programme. On the other hand, they will suspend the programme if the conditions are not being met. If someone is in a Troika programme and they do not meet the conditions set, the ECB will stop buying these bonds. Who, then, is going to buy them? Is there a risk of the ECB leading countries into default?”
Investor sentiment
Turning to investor sentiment, Silberston asks whether there has in fact been a fundamental shift in bond investors’ mindsets, and subsequently their investment decisions. He questions, “What is an investor’s reason for buying government bonds? Fundamentally, investors’ reasons for purchasing government bonds relate to the relative safety, security and stability of the investment. Yet there has been a wholesale shift in the behaviour of this bond market, with extreme volatility occurring in Italian and Spanish bond markets.”
Portfolio positioning
Looking at the Investec Fixed income and Currency team’s portfolio positioning, Silberston notes that the team does not hold and has not bought Spanish and Italian bonds. He comments, ‘We have not bought any, and we still haven’t bought any because they are behaving like risky assets. Risky assets and high yield have their place, but when you buy that sort of asset you need to understand the balance sheet. Conversely, when you buy the bond, you’re buying into the solvency of a government and that’s the real issue. So we’ve avoided it.’
He goes on, “The only hedge you can really have for the risks that this all goes wrong is not to own anything. We prefer higher yielding countries that we believe are safer and more secure – Canada, Australia, Sweden, and Norway, for example, which should offer superior returns. It is no surprise the currencies here have been very firm.”
He favours those countries that are not tied too much into the risks around the Eurozone and which are exhibiting characteristics usually associated with bond markets. Also,he notes that investor flows into some emerging markets, for example South African bonds, have risen as investors flee the euro zone, given the attractive yields available.
