John Chatfeild-Roberts: Inflation, Europe and bonds set to dominate


With half the year already over, now is a good time to take stock of the global macro  situation. The past six months have been dominated by four principal factors: the low price of oil, the material appreciation of the US dollar, quantitative easing and the precipitous fall in sovereign bond yields. The combination of these factors has created an environment conducive to robust equity returns.

For a world economy still suffering the after-effects of the great financial crisis, cheaper oil for an extended period of time should be a significant fillip. Less money is required to travel, transport and manufacture goods, heat buildings and so on, and the savings are likely to be spent on more consumption and, hopefully, investment. A low oil price is good for consumers but bad for oil producers.

Hand in hand with the oil price has been the steadily strengthening dollar, which should mean imports to the US become cheaper, potentially giving US consumers more bang for their buck. Exporters from Europe have also gained a price advantage, while US multinational firms are finding their profits in dollars being squeezed.

The emergency interest rates around the globe, to which we have become so accustomed, have been in place for many years now, and the oil price falls have helped to depress annual inflation numbers. Both of these factors have benefited bond and equity markets. However, as the oil price decline drops out of the annual numbers, inflation could rise and provide an upward bias to interest rates, which would then drive bond yields upwards and prices down. This is likely to create increased volatility in equity, fixed interest and currency markets while investors weigh up a change in the backdrop that has existed for over six years.

When it comes to government bonds, the recent falls in yields – and rise in prices – have been relentless. Both UK and US 10-year bond yields bottomed in late January at yields of 1.33 per cent and 1.64 per cent respectively. However, these moves were nothing compared with their European counterparts: the German 10-year bond yield bottomed at 0.05 per cent in late April. The yields on all these bonds have subsequently risen but none more so than the German bonds, which have seen extraordinary volatility for what has traditionally been such a “safe” investment.

The US Federal Reserve may have tapered its monthly QE down to zero in September 2014 but, during January, Europe joined the money printing party. European Central Bank president Mario Draghi surprised markets by announcing a larger-than-expected programme, committing to buy €60bn a month of predominantly sovereign bonds until at least September 2016, or until inflation is close to the target of just below 2 per cent.

An improving European economy and the ECB’s QE efforts have helped to improve confidence in the eurozone but the unresolved issue of Greece and its unsustainable debt position continues to weigh on sentiment.

Greece, and the negotiations surrounding its stretched finances and ongoing membership of the eurozone, continue.

However, these discussions remind us of Europe’s crisis management strategies over recent years, with compromise agreements appearing late in the day but often lacking sufficient completeness or substance to make them anything more than short-term solutions.

At the time of writing, the situation is in such flux that it would be folly to make any concrete predictions, but one thing is certain: until a more permanent remedy is found, Greece’s perilous financial situation has the potential to unsettle markets and interrupt the fragile European recovery.

John Chatfeild-Roberts is chief investment officer at Jupiter Asset Management