Cash is king
The past year has seen risk aversion take centre stage and continues to do so amidst political events and market uncertainties. A recent survey conducted by Bank of America Merrill Lynch has found cash holdings to be at 15 year highs, as investors lean towards a cash preference over low yielding debt securities impacted by market fluctuations and events.
In times of uncertainty, low yielding debt issues, such as investment grade sovereign bonds tend to be the preferred choice when dealing with a perceived downturn in economic activity. Though, as has been the case over recent months, negative yielding sovereign debt in the Eurozone and yields close to zero for 10 year notes in investment grade alternatives globally are pushing investors away from historical choices and down the maturity ladder in search for returns.
Such movements increase the likelihood of experiencing a risk-reward tradeoff in disequilibrium.
The problem the European Central Bank (ECB) is dealing with, leading up to tomorrow’s much awaited policy meeting, is added pressure by the European banking sector on the impact the current quantitative easing (QE) measures are having on banks’ profit margins, notably the current negative overnight deposit rate of -0.4%.
Over and above, the €80bn of monthly asset purchases in place by the ECB are proving difficult to meet due to the restrictions on the inclusion of negative yielding debt in the asset purchasing program.
Negative yields affect a substantial portion of investment grade securities below 10 year maturities in the Eurozone. This is supported by the increase seen in Investment Grade bond issues worldwide year on year as a result of lower interest rates.
Flexible easing of the restrictions and rules of the ECB’s QE program may be seen at tomorrow’s meeting, although should no action be taken, the market could nonetheless expect to receive a hinting tone by Mario Draghi on future actions to be taken by the ECB in subsequent meetings.
Rumours of tapering the asset purchasing program as soon as March 2017 are already surfacing in the markets and whilst conflicting opinions may arise, inflationary data and a restructuring of the current asset purchasing program should be the sole focal points investors should take for the time being.
Globally, risk aversion and preference for cash holdings has also been strengthened by the possibility of a Trump presidency in November’s upcoming elections. Gold too has benefitted off the presidential election volatility hand in hand with the low yield environment throughout Investment grade bond markets.
The Brexit uncertainty also has its bit to play in the preference for cash holdings. Although positive word this week has seen the possibility of a final Brexit deal being taken through a parliamentary vote, investors are still wary of the implications Brexit will have on the UK and the Eurozone when Article 50 is triggered in March 2017.
To set a tone of optimism for the UK, however, inflationary data was higher in latest figures as the weaker currency following weeks of sell-offs and the fading effects of the energy crisis have the possibility of boosting the UK’s economic performance in coming quarters.
Focus will now be on tomorrow’s ECB policy meeting, though beforehand, tonight’s final US presidential debate could also sway market sentiment for the weeks to come.
This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.