12.01.18

Snapshots is a big fan of the mindfulness app Headspace. Keeping a clear head, being open-minded and letting go of presumptions is going to be very important in a post Quantitative Easing environment.

Quantitative Tightening

This is particularly important because of the rapid pace of interest rate normalisation in short maturities. US Libor rates are at 9 year highs. China Libor rates are edging towards decade highs. Euro Libor rates however, are at decade lows. These coincide with the relative actions of the central banks. The Fed is in the third year of a (gradual) rate hiking cycle. China is pursuing mini hikes to dampen leverage in its economy. The ECB is still easing but this is expected to stop later this year.

Housing as a Fixed Income Proxy

A fixed income proxy that will be sensitive to tightening is the world’s highly elevated housing markets. Housing is a complex hybrid instrument in that it has speculative, utility and institutional participants. It has varying levels of equity with credit leverage and is sensitive to inflation (through rents and principal values) and interest rates (through cost of servicing and relative value to risk free rates).

We think in this post crisis world equity cushions are broadly healthy but there will be a wealth effect if they are eroded. This could hit consumer confidence. We are therefore watching real estate indices very closely.

European NPLs

The European banking system has come a long way since the crisis. Banks are generally well capitalised and will not suffer from any more RWA inflation as Basel IV is now finalised.

The ECB Asset Quality Review means that NPL definitions and provisions are aligned across Europe. The ECB has been keen to accelerate the clean-up process of the banks under its supervision but some Southern European banks have been stubbornly sitting on large NPL balances.

We think a trigger to start selling is about to kick in. The new accounting standards “IFRS 9 Financial Instruments” came into force on 1 January 2018 and will require banks to provision against loans that are “unlikely to pay” on top of the loans that have stopped paying. We think this will accelerate NPL disposals which will further clean up the banking sector.

Good luck.

 

Asif Godall
Co-Chief Investment Officer