Transcript Q - Engaged Investor

Central Banks in Uncharted
Territory
A Roadmap for Bond Investors
Markus Krygier
Senior Global Fixed Income Manager
21st May 2009
Setting the Scene – Extraordinary Challenges for Policy Makers
[R]ecessions associated with financial crises tend to be unusually
severe and their recoveries typically slow. Similarly, globally
synchronized recessions are often long and deep, and recoveries
from these recessions are generally weak.
Countercyclical monetary policy can help shorten recessions, but
its effectiveness is limited in financial crises. … These findings
suggest the current recession is likely to be unusually long and
severe and the recovery sluggish.
Source: IMF, World Economic Outlook, April 2009
Source: CAAM
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First line of Central Bank Defence – Interest Rates Converging to Zero!
The crisis breaks
% 7
7
6
6
5
5
4
4
3
3
2
2
1
1
Fed Funds Rate
ECB Refi Rate
%
UK Base Rate
Apr-09
Jul-08
Oct-07
Jan-07
Apr-06
Jul-05
Oct-04
Jan-04
Apr-03
Jul-02
Oct-01
Jan-01
0
Apr-00
0
Source: Bloomberg, CAAM
Source: CAAM
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Second Line of Defence – Quantitative Easing (QE)!
n Q: What is quantitative easing?
n A: The Bank of England defines QE as follows:
“[As] Bank Rate approaches zero, further reductions are likely to be less
effective in terms of the transmission to market interest rates and the
impact on demand and inflation. And interest rates cannot be less than
zero.
The MPC therefore needs to provide further stimulus to support demand
in the wider economy. It boosts the supply of money by purchasing
assets like Government and corporate bonds – a policy sometimes
known as 'Quantitative Easing'. Instead of lowering Bank Rate to
increase the amount of money in the economy, the Bank supplies
extra money directly.”
Source:http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm
Source: CAAM
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Quantitative Easing – The New Image of Monetary Policy
Central Bank Assets (% of GDP)
Source: Barclays Capital
BoE’s Cumulative APF Asset Purchases
Source: Bank of England
Source: CAAM
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Q&A about QE
n Q: Is quantitative easing bad for government bonds?
n A: It depends ….. on whether QE triggers inflation. If it doesn’t trigger
inflation it is likely to be mildly bond positive.
Recall:
Nominal Bond yields = Real Bond Yields + Inflation Expectations
n Q: Why would QE trigger inflation?
n A: Like with any (monetary) stimulus, if withdrawn too late, it will over
stimulate the economy and result in inflation pressure. This, however,
would qualify as a policy mistake and is not an unavoidable result of QE. It
is not more difficult to unwind QE than it is to implement the policy
Source: CAAM
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Q&A about QE
n Q: Are we close to over-stimulating “the” economy?
n A: Far from it. While there are signs that the pace of economic contraction
has recently been slowing, most economies are still firmly in recession
with disinflationary/deflationary economic slack mounting.
12
%
%
US GDP Grow th (yoy)
UK GDP Grow th (yoy)
Germ any GDP Grow th (yoy)
10
8
10
8
Mar-08
Mar-05
-8
Mar-02
-8
Mar-99
-6
Mar-96
-6
Mar-93
-4
Mar-90
-4
Mar-87
-2
Mar-84
-2
Mar-81
0
Mar-78
0
Mar-75
2
Mar-72
2
Mar-69
4
Mar-66
4
Mar-63
6
Mar-60
6
Source: Bloomberg, CAAM
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12
Source: CAAM
Q&A about QE
n Q: Given the overwhelming size of (fiscal and) monetary stimulus,
won’t there be a sudden burst of economic activity i.e. a swift Vshaped recovery? Wouldn’t such a V-shaped recovery fan inflation
expectations and thus hurt bonds?
n A: Unlikely in our opinion. First, policy stimulus is only
overwhelming in absolute numbers. Relative to the size of the
problem (the deepest recession and the most pronounced financial
turmoil since the 1930s ) the stimulus is not overly impressive.
Second, history suggests that any recovery will likely be slow and
“underwhelming”.
Source: CAAM
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Q&A about QE
n Q: For government bonds, inflation seems to be the key to future
performance. But what about corporate bonds?
n A: Quantitative easing has been part of a strategy to fight the
global credit crunch which had resulted in exploding credit
spreads. If policies remain sufficiently stimulative, credit spreads
will likely tighten back further.
Recall: Corporate bond yield = Govt. bond yield + Credit Spread
Source: CAAM
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Where are we going from here? A Roadmap for Bond Markets
n Baseline (sluggish recovery with little inflation pressure)
n Bond yields will fall further
 Strategy: Overweight bonds (prefer Eurozone over US and UK)
n Yield curves will flatten
 Strategy: Overweight longer maturities
n Credit spreads will tighten
 Strategy: Overweight Corporate Bonds
n Alternative Scenario (V-shaped recovery with burst in inflation expectations)
n Bond yields sharply higher (global bond sell-off)
n Yield curves will flatten
n Credit spreads will tighten sharply
Source: CAAM
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Issued by Crédit Agricole Asset Management (CAAM) London Branch, which is authorised by the
Autorité des Marchés Financiers and regulated by the Financial Services Authority for the conduct of
investment business in the United Kingdom. This report is for information purposes for professional
investors only and is not intended as an offer or solicitation with respect to the purchase or sale of
securities. Opinions and estimates may be changed without notice. It may not be copied or distributed
to any other person and must not be distributed to retail customers in the UK. Investment in the fund
should be made on the basis of the current Prospectus which is available from Crédit Agricole Asset
Management (CAAM) London Branch, 41 Lothbury, London, EC2R 7HF. The past performance of
investments is not necessarily a guide to future returns. Changes in rates of exchange and other
factors may cause the value of an investment to go up or down.
Source: CAAM
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