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ECB Preview: The Right Dose of QE

According to Andrew Bosomworth, PIMCO’s head of portfolio management in Germany, the European Central Bank (ECB) faces a tricky challenge at its Governing Council meeting. On December 8th, it must decide on the minimum amount of quantitative easing (QE) needed to return inflation to target – and in what size doses it should be administered.

So far, the ECB has conducted two rounds of QE and committed to buy €1.74 trillion in assets, mostly government bonds. Phase one began in March 2015, spanned 13 months and saw €60 billion in asset purchases per month; phase two began in April of this year and is scheduled to run for 12 months at a rate of €80 billion per month.

The PIMCO specialist believes striking the right balance between the stock (of assets to purchase) and flow (the rate of purchases) will be key. “Both current inflation and projections for next year remain far below the ECB’s just-under-2% target, supporting the argument for more QE at a high monthly purchase rate. But monetary policy works with a lag, and because the ECB has already administered a lot of easing, further purchases risk creating asset bubbles and hurting savers – an argument for phasing out QE as soon as possible.”

In his opinion, there may appear to be little difference between purchasing €80 billion in assets per month for six months and purchasing €60 billion in assets for nine months (two options likely to be on the table). But while the ECB might be tempted to reduce the monthly purchase rate now, he thinks maintaining higher monthly purchases for a shorter period is more likely to square the stock-versus-flow circle, for three reasons.

First, maintaining €80 billion in monthly purchases minimizes the risk of tightening financial conditions, even if it involves purchasing a smaller total stock of assets. Financial markets are sensitive and might interpret a smaller purchase rate as a signal that QE will stop soon.
Second, committing to a shorter-term policy gives the ECB more flexibility to change course. If it turns out that nominal economic growth recovers strongly and durably – say, above 3.5% – the ECB could slow purchases during the final quarter next year and stop altogether by mid-2018. If growth remains weak, it could opt to extend QE into 2018. We see little cost to postponing the decision.
Third, interest rates and the euro are likely to rise for fundamental reasons independent of QE once growth recovers. Winding down QE under those circumstances would reduce the risk of tighter financial conditions that could push the economy back into recession. From a risk management perspective, we think it’s better to delay reducing monthly purchases until there is a high degree of confidence in economic forecasts.

Owing to the scarcity of eligible Bunds, Bosomworth believes any extension of QE will likely require relaxing some of the ECB’s rules for purchasing government bonds, and so the ECB may change its rules so that it can buy bonds at yields below the deposit facility rate and in quantities that deviate from its capital key. “With so much government debt on its balance sheet and peripheral banking systems (especially Italy’s) dependent on ECB liquidity as never before (see chart), a sovereign debt restructuring would be a crisis for the ECB. We therefore think relaxing the 33% cap on purchases for any one bond or issuer is less likely, and may be left in the toolkit for the next recession. Let’s hope that’s a long way away.” He concludes.

ABN AMRO Sells its Private Banking Operations in Asia and the Middle East

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In line with the strategic update as announced on 16 November 2016, ABN AMRO has decided to sell its private banking operations in Asia and the Middle East to LGT, a leading international private banking and asset management group.

Jeroen Rijpkema, CEO of ABN AMRO Private Banking International said: ‘Private banking is a core activity of ABN AMRO. After a strategic review, we have decided to focus on further strengthening and growing our private banking activities in Northwest Europe. The transfer of our private banking business in Asia and the Middle East is the logical next step in implementing this strategy. We are happy to have found in LGT a strong and solid partner to ensure continuity of service in the best interest of our clients and staff involved’.

ABN AMRO Private Banking manages around USD 20 billion (EUR 18.5 billion) of client assets in Singapore, Hong Kong and Dubai, representing about 10% of ABN AMRO Private Banking client assets worldwide. The transaction is subject to approvals from the relevant authorities and closing is expected in Q2 2017. ABN AMRO expects to realise a substantial book gain.

In the region, ABN AMRO will continue to offer financial services to its Corporate Banking clients active in amongst others Energy, Commodities & Transportation, the Diamond & Jewellery sector and Clearing.

Most Banks Don’t Need More Capital, But More Flexibility To Use It

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Despite having much stronger capital bases than before the financial crisis, banks around the world remain exposed to capital-related confidence shocks, according to S&P Global Ratings‘ Most Banks Don’t Need More Capital, But The Flexibility To Use It In Times Of Stress.

“This apparent paradox reflects the effectiveness of the significant increase in minimum regulatory capital requirements in ensuring that systemically important financial institutions (SIFIs) have enough bail-in-able resources to absorb stress losses in a resolution,” said S&P Global Ratings credit analyst Bernard De Longevialle. “However, at the same time, the higher requirements have also lead to a parallel shift in what the market believes are the minimum capital levels banks should permanently respect to keep its confidence.”

As a result, in period of stress, banks might react with many of the same procyclical behaviors that we’ve seen in the past. Current considerations by Europe’s Single Supervisory Mechanism to split Tier 1 Pillar II requirements into a hard “requirement” and a softer “guidance” component may give welcome additional flexibility to Europe’s large banks to absorb unexpected shocks without triggering confidence-sensitive coupon suspension.

Regulators have been successful in forcing the banking system to build a much stronger capital base than before the crisis.

This achievement should not, however, hide the fact that most of these capital resources would be available only as part of a resolution. Over the past six years, new forms of concurrent regulatory requirements have emerged in addition to going-concern risk-sensitive metrics. In assessing where large banks in Europe and the U.S. stand according to these metrics, we observe that their effective loss-absorbing margins above regulatory requirements have not improved on average since before the crisis.

International standard setters didn’t intend for these regulatory buffers to be viewed as establishing new minimum capital requirements. However, as seen earlier this year, the perceived risk of restrictions on distributions to shareholders or hybrid instrument holders can spread to the wider credit markets.

A further increase in regulatory minimum capital requirements could have unintended consequences, but flexibility to use capital buffers when needed would in our opinion benefit the resilience of the world’s banking system.

Taking Stock of the U.S.

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Stronger GDP growth is the key to sustaining U.S. equity momentum.

As we enter December, the market continues to chew over the implications of a Donald Trump presidency. Last week, my colleague, Erik Knutzen, CIO of Multi-Asset Class, examined the outlook for emerging markets debt and equities. This week, we take a look at the prospects for U.S. equities.

There’s been a lot of noise and excitement about the so-called “Trump Bounce” in equities, but I want to dig a little deeper and look at some of the factors that are likely to sustain it. The most important element in equities’ continued recovery is a pickup in expectations for stronger GDP growth. Indeed, this may already be in the works.

The most recent figures, for example, show an upwards revision in Q3 GDP—up from 2.4% to 2.9%1, largely driven by consumer spending. This was better than anticipated, and although estimates tend to fluctuate throughout a quarter, the Atlanta Fed is projecting Q4 GDP to be over 3%. So, if this plays out, it represents a 2.25% increase in GDP for the whole year. That’s a pretty decent tick up from the 1.5% the U.S. economy experienced throughout 2015 and much of 2016.

Fiscal Boost?

Next, you need to factor in the new administration’s plans for meaningful fiscal stimulus. Indeed, Steven Mnuchin, the Treasury secretary designate, made a case for greater fiscal policy intervention only last week. This included much talk about tax cuts, both corporate and personal, together with the long-heralded increase in infrastructure spend. Taken together, and if implemented, these initiatives should provide the tailwind that will drive U.S. GDP growth above the levels we’ve seen in recent years.

With a stronger level of growth, earnings should improve. Back in the spring, this was an area of concern for us. Accelerating earnings growth would be the strong foundation for further improvement in U.S. equity markets and support the higher P/E multiples that, for the first half of 2016, were driven by lower bond yields.

Industry Sectors a Mixed Bag

So, which areas of the U.S. stock market are most likely to benefit under this new environment and which ones will be left out in the cold? On the positive side of the ledger, financials should do well because of the expectation of interest rate increases and less rigorous bank regulation. Domestic cyclicals and energy companies should also be among the beneficiaries of faster domestic growth.

The small-cap space is also enjoying a strong rally. Since its November 3 low point, the Russell 2000 Index is up nearly 15% through the end of November. In contrast, the S&P 500 has posted a return of around 6%.

Health care, however, is a mixed bag. Tom Price, the proposed Secretary of Health and Human Services, is a vocal critic of the Affordable Care Act. In fact, he’s likely to try to do away with “Obamacare” altogether and replace it with a more market-based system. As a result, investors are struggling to figure out who’ll be the winners and losers if the current system begins to unravel.
Risks?

Trade and the Dollar

So what are the risks to this more optimistic scenario? One is that trade becomes an issue. There was a lot of anti-trade rhetoric during the recent U.S. election, although things have quieted down a bit since then. But tensions could reignite next year when Trump takes office. A trade “war” of sorts could be a meaningful drag on global GDP growth. Trade has in fact already been slowing over the past three years due, in part, to protectionist measures implemented in many countries.

The stronger U.S. dollar is making life increasingly uncomfortable for many large-cap exporters. Growing dollar strength has major implications for large international companies and, by association, their earnings growth. Since the U.S. election, the greenback has already risen by 4% and looks set to rise higher. And there’s near-universal agreement that the Fed will increase rates later this month, which will put additional upward pressure on the currency and, therefore, on big global exporters.

Net-Net, We have a Positive Outlook

But despite these concerns, the prospects for U.S. equities look far healthier than they did a month ago. So the decision of our Asset Allocation Committee just over a week ago to raise our 12-month outlook for U.S. equities to slightly above normal has, so far, proved to be the right one. Stay tuned to see whether this remains the case.

Neuberger Berman’s CIO insight by Joseph V. Amato

Safra National Bank of New York Acquires Bank Hapoalim’s Private Banking Business in Miami

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Safra National Bankof New York announced that it has signed an agreement to acquire Bank Hapoalim’s private banking business in Miami. The agreement covers qualifying clients and their relationship management teams who are focused on high net worth clients across Latin America.

This acquisition is a logical extension of Safra National Bank of New York’s private banking business for Latin America, where it has been providing premier private banking and financial services to high net worth clients for more than 30 years. With this transaction, Safra National Bank of New York and its subsidiary, Safra Securities, LLC, further strengthen their private banking business and the global wealth management capabilities of the J. Safra Group.

Jacob J. Safra, Vice-Chairman of Safra National Bank, commented:
“We are determined to play a leading role in the consolidation of the private banking market. Our capital strength, family ownership and 175 years of experience give us great flexibility to do such transactions.”

Simoni Morato, CEO of Safra National Bank of New York, said:
“We look forward to welcoming the clients and employees of Bank Hapoalim in Miami to our organization. Bank Hapoalim’s private banking business in Miami fits perfectly with the strategic vision of the J. Safra Group and Safra National Bank of New York, and we are confident we will add immeasurable value to clients.”

The acquisition is expected to be completed during the course of the first quarter of 2017, subject to regulatory clearance. Financial terms are not disclosed.

Pérez Art Museum Miami Receives $15 Million Gift from Philanthropist and Patron of the Arts Jorge M. Pérez

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Pérez Art Museum Miami (PAMM) has announced that business leader and long-time museum supporter Jorge M. Pérez will continue his patronage of the museum with a new $15 million donation. The contribution, which will be gifted over the next 10 years, will consist of $5 million in funds for the acquisition of works by Latin American artists, $5 million in endowed funds for procurement of additional works and an immediate bestowment of over 200 pieces from Pérez’s personal collection of Cuban artworks. The donated works will be featured in a new exhibition celebrating this momentous donation in the fall of 2017.

“This tremendous gift is another affirmation of Jorge and Darlene Pérez’s commitment to Miami’s museum,” said PAMM Director Franklin Sirmans. “This gift significantly improves upon the museum’s holdings and adds depth to a vitally important area of the collection that Pérez has always championed since coming on as a board member more than 20 years ago.”

Pérez has been one of the city’s leading advocates for contemporary art. This new gift will make PAMM home to one of the largest collections of contemporary Cuban art in any American museum. Earlier gifts by Pérez have included work by Cuban modernists Amelia Peláez, Wifredo Lam and Mario Carreño along with works of other Latin American modernists.

As Miami’s flagship contemporary art museum, collecting the work of Cuban artists and documenting the Cuban Diaspora fits with PAMM’s mission to represent its place in the world—geographically, conceptually and intellectually. Cuba, equally a part of Latin America and the Caribbean, has been an area of sustained interest at PAMM going back to its beginnings as a presenting institution. Over the years, the museum has presented solo exhibitions and projects by many Cuban artists such as Amelia Peláez, Wifredo Lam, Ana Mendieta, Glexis Novoa, Enrique Martinez Celaya, José Bedia and Quisqueya Henriquez.

In addition to the Cuban art collection, which will be supplemented by the first million dollars to augment the gift with new acquisitions of Cuban art, PAMM will spend $1 million a year in the four successive years to acquire works by Latin American artists to further buttress that aspect of the collection.

As an international museum of modern and contemporary art, which seeks to be the leader in archive for the study of art from Latin America and the Caribbean, the PAMM collection embodies much of the museum’s philosophy to lead the discussion of contemporary art outward from its home in Miami. To complement this philosophy, the first half of the gift will focus on collecting the works of regional artists, and the remainder of the gift will be used to acquire international contemporary art in perpetuity.

UBS Wealth Management Merges its Subsidiaries in Germany, Italy, Luxembourg, the Netherlands and Spain

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UBS has combined most of its Wealth Management businesses in Europe into one legal entity, UBS Europe SE. The new European subsidiary is headquartered in Frankfurt, Germany and will operate in European markets through a network of branches.

According to a press release, the choice of a societas Europaea as the corporate structure for the entity provides UBS with strategic flexibility.

By merging its subsidiaries in Germany, Italy, Luxembourg (which already includes the branches in Austria, Denmark and Sweden), the Netherlands and Spain into one legal entity, UBS has taken an important step to simplify its governance structure and increase operational efficiency across its European operations. This move allows UBS to more effectively invest in its European wealth management business and enhance the offerings and services it provides to clients in these important markets.

UBS Europe SE will be led by a management board whose members are: Birgit Dietl-Benzin, Chief Risk Officer, Fabio Innocenzi, Market Representative (Wealth Management), René Mottas, Market Representative (Wealth Management), Andreas Przewloka, Chief Operating Officer, Thomas Rodermann, Market Representative (Wealth Management), Stefan Winter, Market Representative (Investment Bank). Thomas Rodermann, who has headed UBS’s German business for the past two years, will assume the role of spokesman of the UBS Europe SE Management Board. The UBS Europe SE Supervisory Board will be chaired by Roland Koch, who has been Chairman of UBS Deutschland AG since 2011. The Market Representatives will lead the branches in their respective country.

Why is the Italian Referendum Important?

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On December 4th, a constitutional referendum is to be held in Italy to vote on amending the Italian constitution. The referendum poses the question:

Do you approve the constitutional bill concerning the dispositions to overcome the perfect bicameralism, the reduction of the number of members of the Parliament, the restraint of the institutions’ operating costs, the abolition of CNEL and the revision of Titolo V of the 2nd part of the Constitution, which was approved by the Parliament and published on the Gazzetta Ufficiale n. 88, on April 15, 2016?

According to Columbia Threadneedle’s Philip Dicken and Andrea Carzana, over the longer term, reform in Italy is critical for increased economic growth and the ultimate well-being of the Italian people, but it is also important to the economy of Europe and the political stability of the EU.

Columbia Threadneedle believes investors should be very aware of the political risks as, in many parts of Europe they see dissatisfaction with globalisation, the rise of populism (and in some cases nationalism) and a frustration with incumbent politicians. Political risk is on the rise and investors need to get used to it they state. “Italy has many fine attributes but has struggled with low growth and political instability. Indeed, Renzi is the third Prime Minister in four years and his government is the 63rd in the past 70 years. If the referendum succeeds the hope is that Italy will have more stability in its political structure, opening the way to economic reforms which could allow the government to tackle several serious structural issues hindering economic growth.”

There are three areas of the economy which they believe need to be addressed:

Labour and demographics – an ageing population with high unemployment amongst the young.
Productivity – persistently low growth and productivity.
Debt and leverage – high public sector debt and a poorly capitalised banking system, but a wealthy population.

They believe the consequences are:

YES VOTE

We believe that this will be received positively by markets, at least in the short term. Renzi would have a mandate for his reforms and would probably seek to amend the Italicum law to head off a possible Five Star win in the expected 2018 general election.
However, if Renzi is not able the change the Italicum law and Five Star continue to gain in popularity from their around 30% in the polls today, then there is an increased risk of a populist, anti-EU, anti-euro government in 2018.

NO VOTE

This would be negatively received in the short term, in our view, but the longer-term impact would be less clear.
Renzi could resign and a technocratic government be formed by the President, Sergio Mattarella. The new PM could again be Renzi who would continue to argue for reform, not least because the Italicum law would be neutered by the unreformed Senate retaining its power.
A technocratic government could be led by others or a general election could be called, both leading to periods of uncertainty.
Or, Renzi may not resign as threatened and simply continue as PM, albeit with reduced political capital.

Gauging Europe’s Political Risks

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Key European political events are now in focus as investors look for another potential populist backlash. The Italian constitutional referendum on Dec. 4 comes as the conservative candidate in France’s presidential election next year is being finalized. This week’s chart helps explain the market backdrop.

Enlarge

Deeper structural problems are the backdrop to Europe’s political challenges. As the chart shows, investors have shunned eurozone banks relative to global counterparts. Italian bond yields have risen versus German yields before the referendum, yet the narrow spread also highlights the European Central Bank’s (ECB’s) efforts to calm the 2010-12 debt crisis and revive growth.

Stagnation fuels populism

Italy’s referendum as well as presidential elections in Austria and France should show whether populist parties are gaining greater sway. Election polls have wrong-footed investors this year, yet we see a limited risk of populist governments arising.

Polls currently suggest the Italian referendum, supported by Prime Minister Matteo Renzi, is likely to be voted down. Any Renzi resignation afterwards should result in a caretaker government that is likely to focus on reforming Italy’s electoral law. A yes vote could spark a brief relief rally in regional bonds and bank shares, in our view. We see a strong “no” vote delaying any fixes to the country’s sick banking system and emboldening populist parties. In France, polls show the successful conservative candidate for president as the favorite in any contest with far-right populist Marine Le Pen in the final round next May.

Even if populists don’t win now, the economic stagnation and political frustrations driving their rise are still at play. Europe’s leaders face other big challenges: managing Brexit, the anti-trade backlash and the migration crisis.

We expect investors to remain pessimistic on Europe relative to upbeat U.S. reflation prospects. We are neutral on European government bonds and favor investment-grade debt due to the ECB’s ongoing purchases. We are underweight European equities on concerns about the growth outlook. Read more market insights in my Weekly Commentary.

Build on Insight, by BlackRock, written by Richard Turnill

BlackRock: “Flexible Income Strategies Have Never Made more Sense than They Do in the Present Environment”

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According to Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income, investing in flexible fixed income strategies has never made more sense than it does in the present environment. In a world in which developed market interest rates are extraordinarily low or even negative, and where monetary policy regimes diverge across the globe, Rieder believes that maintaining investment flexibility is vital to successfully navigating markets. In an interview with Funds Society, he talks about the lack of utility of the extraordinarily low interest rate levels for stimulating real economic growth, and the anticipation of a rate hike as the Fed to continue its path of slow interest rate normalization. Hereunder, his answers:

What does the most recent payroll growth slowdown mean for the timing of an interest rate hike?

Without question, payrolls growth in recent months has slowed from its extraordinary pace of recent years, but in our view, that has more to do with the economy’s approach toward full employment and the diminished ranks of qualified applicants searching for positions. Interestingly, this has also resulted in the improvement of wage levels, which are now running at an impressive 2.8% year-over-year, which is a clear representation of growing tightness in the labor markets. Overall, payrolls are fairly strong for this stage in the economic cycle, so with firming wages, and the modest increase in inflation that should follow, we think the Fed should be able to continue on its path of slow interest rate normalization.

Do you think a December rate hike is imminent and what would that mean for the broader economic outlook?

Understandably, the Fed held off from raising policy rates at its recent meeting, coming nearly a week before a highly contested general election in the U.S., but we do anticipate the Committee will make a quarter-point move in December. Still, we believe bond markets have largely priced in such a move, and the gradual rise in interest rates should have only a modest impact on the overall economic outlook. Indeed, as we have argued many times in the past, the utility of extraordinarily low interest rate levels has long since passed in stimulating real economic growth and for some time now has solely been influencing the financial economy as a price-supporting mechanism.

Does a flexible fixed income strategy still make sense in today’s environment?

In our view, flexible fixed income strategies have never made more sense than they do in the present environment. Indeed, we live in a world in which developed market interest rates are extraordinarily low (and in some cases, are negative), monetary policy regimes are continuing to diverge across the globe, a monetary-to-fiscal policy transition is potentially in the cards, and the inflation outlook is evolving globally. And that is to say nothing of the political and event risks that abound in the world today, or the fact that the sources of global growth are rapidly shifting by region. In this environment, we believe that maintaining investment flexibility is vital to successfully navigating markets, and within that framework, the critical importance of “globalizing” ones’ view of fixed income cannot be overstated.

What elements differentiate the BGF Fixed Income Global Opportunities Fund’s strategy from its peers?

For this strategy, we focus on generating consistent, attractive risk-adjusted returns through various market cycles while maintaining the risk profile of traditional fixed income investments. To do this, we invest in a diversified portfolio of beta and alpha sources, and aims to lower absolute risk while achieving attractive risk-adjusted returns. The fund employs BlackRock’s best ideas to identify attractive opportunities across global fixed income markets and is supported by the firm’s vast risk management platform and resources.