Investors favour Eurozone equities and credit ahead of key central bank meeting
Asset managers say the outlook for Europe’s equity and corporate bond markets is improving, as they await a critical meeting of the European Central Bank (ECB).
At its meeting on Thursday, the ECB is expected to discuss slowing the pace of its asset purchases under the pandemic emergency purchase program (PEPP), on the back of higher-than-expected GDP growth and inflation.
A plan to reduce asset purchases could be announced “as soon as this week’s meeting and start in the fourth quarter”, says US-based asset manager Neuberger Berman, pointing to strong suggestions from the ECB’s chief economist Philip Lane.
“We think this is likely, and that the PEPP will be closed out by March,” writes Patrick Barbe, head of European investment grade fixed income at Neuberger Berman.
Eurozone GDP growth expectations have continued to improve in recent weeks, with output currently predicted to reach pre-pandemic levels by the end of 2021.
Neuberger Berman is expecting “more than 5 per cent growth” in both 2021 and 2022. This is higher than official estimates, which forecast yearly growth of 4.8 per cent and 4.5 per cent respectively.
Nevertheless, Barbe adds: “We do not think this implies anything about interest rate policy, however, particularly following the distinction drawn between asset purchases and rates by Jerome Powell at the Jackson Hole conference.”
At the annual central banking conference in August, US Federal Reserve chair Powell reiterated that the decision to raise interest rates from near-zero would be based on a “different and substantially more stringent test” than any decision to reduce asset purchases.
Neuberger Berman believes a decision from the ECB on interest rates is “highly unlikely before next spring, when the nature of current inflation is clearer”.
The world’s largest asset manager, BlackRock, believes that the ECB’s decision over tapering its asset purchases is unlikely to send a broader signal of the central bank’s future policy.
“The ECB may choose at its September meeting to reduce the pace of asset purchases under its pandemic emergency purchase program (PEPP),” writes BlackRock Investment Institute in a recent note, pointing to the backdrop of easier financing conditions and lower bond yields.
The asset manager suggests this would be an “operational decision” rather than an indication of future policy, with the central bank also likely to raise near-term inflation expectations.
“We expect the central bank to reinforce a low-inflation outlook for the medium term, paving the way for additional easing in 2022 and further supporting our tactical preference for euro area equities,” writes the asset manager’s research arm.
BlackRock explains: “The weak medium-term inflation outlook implies that the ECB will need to step up its asset purchase program after the pandemic-era PEPP – which will run at least until March 2022 – expires.”
The asset manager recently upgraded European equities to “overweight”.
BlackRock notes that the economic restart has been “broadening beyond the US”, aided by an acceleration in vaccine rollouts in Europe and other developed markets.
This has led to a sharp rise in earnings upgrades by companies in Europe, while ratio of corporate earnings upgrades to downgrades has stalled in the US.
“This shift in momentum lies behind our recent tactical upgrade in European equities to overweight, and our neutral stance on US equities,” writes BlackRock Investment Institute.
“Valuations remain attractive relative to history and look even more attractive than at the start of the year thanks to strong earnings; investor inflows into the region are only just starting to pick up.”
Meanwhile, Neuberger Berman sees the upcoming ECB meeting potentially improving the outlook for corporate bonds.
“It is in bond markets where the US and Eurozone stories could diverge,” writes Neuberger Berman’s Barbe.
Barbe notes the subdued move in US treasury yields following Powell’s Jackson Hole commentary, which suggests that his upbeat economic assessment and policy statements were already priced in.
“By contrast, we think Bunds yielding -0.35 per cent remain priced for an overly pessimistic view on growth and inflation.”
Barbe notes that Bund yields climbed to -0.09 per cent in May, and adds that they are “likely to be back to zero by the end of this year”.
“For fixed income investors, Eurozone credit therefore presents considerably less downside risk given the current outlook, in our view,” concludes Barbe.
This view was shared by asset manager Muzinich & Co, which expects government bond volatility to increase as the ECB announces a decrease in asset purchases.
“Corporate credit markets are benefiting from strong and improving fundamentals with persistent demand from investors,” writes Erick Muller, head of investment strategy at Muzinich & Co.
“The low value proposition in government bonds is quite a positive argument in favour of credit markets as long as the economic and earnings cycle is robust.”