MAI views

Multi-Asset Investments views – August 2020 - Fiscal support firing on all cylinders

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Our key convictions 

  • Positive on Credit – unprecedented support from both fiscal and monetary authorities should help to ease valuation and liquidity concerns
  • Positive on equities - most countries have reopened on or ahead of schedule. As a result, economic data point to a faster and stronger initial recovery than initially thought while equity valuations are supported by unconditional monetary support
  • Neutral duration on government bonds - monetary arsenal is a clear support for bonds, but unparalleled fiscal stimulus and eventually unprecedented supply should maintain government bond yields in the current range

Our positioning

  • Positive on Credit
  • Positive on Equities
  • Positive on Commodities
  • Neutral duration in our government bonds exposure
  • Long equity call options delta hedged to protect the portfolios where possible

Our views

The tug of war between fundamental supports -  positive macro surprises, vaccine optimism, massive monetary and fiscal stimulus  - and near term concerns  - the recent pick up in virus in the US, US fiscal cliff, earnings recession, US elections and renewed tensions with China  -  continues for markets, with the former taking the upper hand. Among these factors, global fiscal support is firing on all cylinders.

The agreement between European Union (EU) leaders on the €750bn recovery fund and €1.07 trillion seven year budget reached on Tuesday morning is not going to change the cyclical conditions per se. However it reinforces the EU institutional architecture and is an important step toward a stronger and more symmetrical fiscal-monetary policy mix in the Eurozone. The recovery fund was always intended to complement national fiscal policies, but national budgets and monetary policy remain clearly the main policy instrument. Indeed, the size  - we are talking about expenditure below 0.4% of the EU GDP per annum until 2027 - and the timing of disbursement - from 2021 onwards -  underlines that national fiscal policy plus ECB QE will continue to carry the largest share of Europe's virus crisis response.

The most important aspect of this deal for markets however, is not so much its macro impact but the transformation of the EU budget into a proper fiscal tool, equipped with a borrowing capacity. The taboo of debt mutualization is finally broken. Even though the recovery facility is supposed to be temporary, it creates a precedent which, as shown by the institutional achievements in Europe over the last decade, could become a permanent feature. This will help keep the sovereign spreads in check (cf. chart below), reduce Eurozone assets risk premia and could ultimately generate a boost to confidence.

The focus is now on US Congressional debate around the next fiscal stimulus bill. While risks are toward some negative headlines on negotiations over the next week or two, an at-least 1 trillion USD package (Democrats are proposing 3.5 trillion USD) remains likely in our view, over the next couple weeks. Indeed, despite some disagreement on details, the major aspects of the bill have the support of both Republicans and Democrats. That includes a partial extension of enhanced unemployment benefits, probably less than 600 USD per week, and aid to state and local government. Negotiations may push bill passage beyond the expiration of enhanced unemployment benefits at the end of July, but new legislation would likely provide for retroactive payments to make up for any period of reduced benefits.

Overall, estimates of enacted discretionary fiscal easing stand now above 9% of GDP for developed economies. These whopping numbers will just be increased as they don’t even take into account the upcoming US fiscal package and exclude soft loans and guarantees provided by governments. In this context, we maintain a cyclical tilt in our portfolios, with a positive stance on equities - in particular on European cyclicals and emerging markets – on inflation breakeven and on commodities.

 

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