David Roberts

Trump trumps Italy?

David Roberts

Has Donald Trump’s threat of a trade war and the ongoing attempts to form a coalition government in Italy changed our stance on bonds?

Let’s start with a summary of our current views. We are a little short credit and rate risk and short the UK, Germany and emerging market bonds. We are long high yield and US investment grade bonds.

How does a trade war and the political situation in Italy impact this?

The Trump chat about trade wars is normal but this time it has had a reaction. Once unleashed, it is difficult to stop and could mean:

  •  Lower global growth and positive inflation
  • US domestic credit and equities will be fine short term
  • US Treasuries will not be great but as yields are at 3%, they are not a bad investment
  • Among the G7 countries, a current account surplus (for example Germany) will be problematic
  • G7 ex-US bonds may find some support as GDP will be down, but inflation may be messy
  • It will be negative for emerging market bonds.

We would therefore remain long domestic US credit but be less aggressively positioned in our long US Treasuries. We really don’t like emerging market bonds.

With Italy, is it more than a storm in an espresso cup? At the very least, it will take months to unwind and will be:

  • Positive for German bunds although we are still happy to short any bond on a negative yield
  • Negative for euro risk
  • Positive for volatility: it will rise

Will the European Central Bank (ECB) change policy for Italy? The political mandate should not allow this but chairman Mario Draghi can do what he wants. I’d still be happy to be short euro credit and rates although at the margin, ECB extension is more likely.

So, a trade war and Italian politics should make risk-free assets more attractive. Perhaps regional winners are more likely, which should favour bunds and US credit. Overall, growth would be impacted negatively, inflation will be positive and volatility will rise. We stick with most of our current views.

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Tuesday, March 13, 2018, 10:14 AM