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18 Mar 2019

How ECB doves are helping higher yielding bonds

Central banks are in retreat across the globe, with the ECB the latest to fall in line. Philippe Bache tells us how this will be to the benefit of higher-yielding bonds.

Last week’s ECB meeting didn’t fall short as far as policy doves are concerned. The central bank eased its stance by lowering its forward guidance on rates. According to its president, Mario Draghi, the first rate hike will now not happen before next year at the earliest. It also admitted that inflation may take longer to reach the 2% target given weaker growth will delay its pass-through from nominal wages to prices. As a result, the bank confirmed drastic cuts to its economic and inflation forecasts for 2019.


Another sugar rush

The bank also acknowledged that the eurozone economy isn’t yet strong enough to wean itself off the sugar rush of stimulus by announcing a third round of Targeted Long-term Refinancing Operations (TLTRO), to be launched in September. The aim is to preserve favourable funding conditions for banks, in the hope they will continue lending. With the second round not due to expire until June next year, this move both exceeded expectations and acted as a wake-up call to current conditions.

That said, the growth outlook should improve in the second half of this year, to an annual rate of around 1.5%. Extending the forward guidance provides comfort for investors as it confirms that monetary policy will remain accommodative for the foreseeable future. The markets aren’t now pricing a rate hike (of 15 basis points) until early 2021, despite Mario’s message, and don’t expect a normalisation to 0% of the deposit facility until mid-2022.


Who, or what, stands to benefit?

The new TLTRO facility should be of benefit to periphery country banks, although some “core” banks which are finding it difficult to issue unsecured loans given high funding costs will also enjoy the support. Approximately €400bn of TLTRO 2 is maturing in June 2020, but those banks under most pressure could now be refinancing their current commitments.

This lesser need for funding, the continuation of the ECB’s covered bond purchase programme (CBPPP3) and low issuance levels are all factors supportive of covered bonds. In the hunt for yield, investors could well turn to assets at the longer end of the curve, helping them to outperform.  Credit it, too, could benefit. There are some short-term headwinds (high issuance and the current weakness in economic activity), but fundamentals remain strong. 

Lyxor EuroMTS Covered Bond Aggregate UCITS ETF - Dist

Credit it, too, could benefit. There are some short-term headwinds (high issuance and the current weakness in economic activity), but fundamentals remain strong.

Feeling the fundamentals

If we are to see an extended return to the ultra-low-yield environment, corporate bonds will clearly be of interest. Increased ECB funding for banks should catalyse credit creation and dampen the probability of any increase in defaults. Earnings growth prospects remain solid and recent results suggest the economy is reviving. The worst may very well be behind us.

After all, investment-grade (IG) corporate bonds are still yielding over 1.0% on average, a very healthy pick up on their government-issued equivalents for an almost negligible risk of default. High yield bonds exhibit even better characteristics and even higher carry prospects.

The level of issuance remains a concern for now. IG issuance is running at over 60% above last year’s volume and March is historically a very heavy month (€38bn average in the past four years). 

Lyxor BofAML € High Yield Ex-Financial Bond UCITS ETF - Dist

Lyxor Euro Corporate Bond UCITS ETF - Acc

Don’t ignore inflation

The ECB’s recent actions should lend more support to European linkers. The rate environment is stable, they are still relatively cheap, and they come with better carry prospects than nominal bonds. In our view, they should be a feature of any portfolios built on European government bonds today.

Ultimately, now that the ECB’s doves have taken flight, the fixed income space is awash with opportunity provided you are prepared to go a little further for yield. Only a really significant, and seemingly unlikely, shift upwards in growth and inflation forecasts would drive EUR rates and their volatility sustainably higher. 

Lyxor EuroMTS Inflation Linked Investment Grade (DR) UCITS ETF - Acc

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Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

Risk Warning​

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

Except for the United-Kingdom, where this communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658, this communication is issued by Lyxor International Asset Management (LIAM), a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2014/91/EU) and AIFM (2011/61/EU) Directives. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

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