Nick Wall, co-manager of the Merian Strategic Absolute Return Bond Fund, Merian Global Investors
The Fed’s decision to cut 25 basis points, while signalling a willingness for deeper cuts, is a positive step but could be a missed opportunity. We believe they should have gone further and cut 50 basis points today in order to weaken the dollar, raise inflation expectations and steepen the Treasury curve.
US economic outperformance, aided by the Trump stimulus and divergent monetary policy vis-à-vis the rest of the world, has led to an exceptionally strong dollar – this hurt growth in the rest of the world given the high amount of liabilities in the reserve currency. Alongside the tariffs disrupting global value chains, these large dollar liabilities have killed global capex and are tipping global manufacturing into recession. Global linkages through multinationals and financial markets mean this is spilling over to the US, and Fed action is the natural antidote. As New York Fed President Williams said “when you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.”
By only cutting in small steps the Fed risks further dollar strength, tightening financial conditions and rendering the lower interest rate inconsequential. Timidity is the path to the zero bound.
We continue to hold long duration positions in the US front-end, expecting further cuts, stay long inflation breakevens and we like US curve steepeners. We continue to allocate risk to emerging market bonds and FX, as well as short dollar positions on the basis that there is more to come from the Fed.
Emerging Market Debt And Currencies Compelling With `Dovish’ Fed
Delphine Arrighi, manager of the Merian Emerging Market Debt Fund, Merian Global Investors
With the market having frontloaded the impact of the long-awaited first Fed rate cut in over a decade, some have been squaring positions ahead of the meeting, leading to some profit taking in the last few days, in a typical example of “buy the rumour, sell the fact.” With spreads having compressed by more than 100 basis points year-to-date in hard currency, and local yields having eased 140 basis points on average since last year’s highs, one might be forgiven for thinking there is little juice left in emerging markets (EM) at the moment. And yet, in an environment where the uncertain global growth outlook forces all central banks to lean towards monetary easing, we believe EM debt remains one of the best investments out there.
Today’s interest rate cut by the Fed tends to confirm that view, with a dovish stance from the US central bank leaving the space for others to follow through. In that context, we believe local currency should continue to play catch up with hard currency, with the J.P. Morgan GBI-EM Global Diversified index having returned “only” 8.3% year-to-date, due to poor FX performance, against 12.6% for the J.P. Morgan EMBI Global Diversified index¹. Of course, we think spreads in hard currency will continue to compress as ongoing inflows meet relatively low supply as most sovereigns continue to err on the side of caution when it comes to debt supply, having the luxury of enjoying improved fiscal space while commodity prices remain well behaved. But a dovish Fed now also gives more space for EM central banks to pursue their own monetary easing, as the interest rate differential with the rest of the world narrows, signalling the end of the strong US dollar cycle and allowing EM currencies to withstand domestic monetary easing. We therefore remain overall constructive on EM debt and continue to see value in selective high yield and new frontier markets.
¹ Bloomberg, 31 July 2019