For investors, the gap between the policy cycles of the US and UK and that of Europe, presents a range of risks and opportunities. Among the most obvious risks are the carry-trades that have been fuelled by historically low borrowing costs. As the prospect of a rate rise in the US and UK draws nearer, asset classes such as high-yield bonds look increasingly vulnerable. Such concerns saw some multi-asset portfolios exit the high-yield arena in June in favour of property assets – a timely decision in light of the violent sell-off a month later. Similarly, US and UK corporate bonds are also vulnerable and investors should be sure to reduce their weightings here before a rate rise becomes reality.
The story is much the same for emerging market bonds – especially those denominated in hard currency – and for emerging market equities. Last summer’s rout of emerging markets, which was triggered by Fed rhetoric, will still be fresh in the minds of many. Higher-yielding currencies such as the Canadian and Australian dollars are also likely to suffer when carry trades start to unwind. Those that benefit will be the funding currencies such as the US dollar, the yen and the Swiss franc.
By contrast, Japan’s quantitative easing is still underway, which should continue to support local equities and maintain a weaker yen. Meanwhile, European monetary authorities must take action to avoid what’s been termed Japanification. If the ECB does unleash a significant asset-purchase programme, it should float both equities and bonds. Despite the record lows we have seen in German bond yields, for example, there is nothing to prevent them moving still lower and some managers have maintained holdings in both European government bonds and euro-denominated credit for just this reason.
Clearly, times are changing and, as always, it will be those investors that can change with them that will fair best in the years ahead.
Nick Samouilhan is a multi-asset fund manager for Aviva Investors
Key points
* The US economy continues to thrive, despite occasional wobbles.
* In contrast to the world’s other mature, consumer-driven economies, Europe continues to drift.
* Japan’s QE is still underway, which should continue to support local equities and maintain a weaker yen.
