Multi-asset allocation views: Uncertainty clouds the outlook for European assets

Sunil Krishnan considers whether Europe can break out of its economic malaise and the factors investors should watch out for in 2020.

1 minute read

Given Europe’s challenging economic backdrop at the turn of the year, we remain underweight euros, using the currency to fund other positions. And while we are underweight ten-year German bunds, we have long positions in ten-year Italian bonds: with negative yields persisting in Germany (-0.248 per cent, as of 22 January), it is hard to see value in bunds, while Italian debt looks more attractive despite the political uncertainty (1.408 per cent, as of 22 January).

The handover of European Central Bank (ECB) leadership from Mario Draghi to Christine Lagarde at the end of last year has created an element of uncertainty. However, in our view this isn’t in itself enough to lead to an immediate change in policy. In fact, Mario Draghi ensured he left with a clear and transparent roadmap for euro zone monetary policy, including the agreement to begin the new asset purchasing programme and guidance that cash rates would likely not rise in 2020.

In that regard, the euro zone is in a position of continuity through change. Additionally, economic conditions don’t currently support a debate for tighter policy, with weak manufacturing activity – including in Germany, the region’s largest economy.

Figure 1: European manufacturing has struggled
European manufacturing has struggled
Source: PMI surveys, Aviva Investors, as of 31 December 2019

Therefore, although the euro is attractively valued in purchasing-power terms, it has remained one of the poorest among major currencies in terms of interest-rate differentials and economic surprises. Major currencies, particularly the US dollar and Japanese yen which also have risk-hedging properties, look more attractive.

Figure 2: 3-month interbank interest rates (%)
3-month interbank interest rates (%)
Source: Bloomberg, as of 15 January 2020

Nonetheless, the ECB’s stance provides support for all the euro zone’s bond markets, thanks to both the asset purchasing programme and current cash rates. However, this support is more limited for German bunds given the low yields already on offer as well as the limits to how much German debt the ECB can buy. In contrast, weaker economies like Italy will be bigger beneficiaries of ECB policy.

How can these factors change?

Firstly, the ECB has appealed to national governments to consider using fiscal stimulus more aggressively to support the region’s economies. We expect Christine Lagarde, as a former finance minister, to maintain this pressure. Any sign of synchronised fiscal stimulus in the euro zone could change the outlook, in particular for the currency, although economic coordination in the area remains elusive. An example of this difficulty can be seen in proposed enhancements to cross-border financial stability, which have recently been postponed until June 2020.

The other risk to using euros to fund other positions is if the euro becomes a consensus funding currency – like the Japanese yen has been for several decades. This can create the risk of crowded trades and lead to violent moves in the market. We are monitoring position indicators closely.

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Apologies, this content is currently unnavailble.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our Privacy Policy.

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL) as at January 2020. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment.

In the UK & Europe this material has been prepared and issued by AIGSL, registered in England No.1151805. Registered Office: St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority. In France, Aviva Investors France is a portfolio management company approved by the French Authority “Autorité des Marchés Financiers”, under n° GP 97-114, a limited liability company with Board of Directors and Supervisory Board, having a share capital of 17 793 700 euros, whose registered office is located at 14 rue Roquépine, 75008 Paris and registered in the Paris Company Register under n° 335 133 229. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH, authorised by FINMA as a distributor of collective investment schemes.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material.  AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”).  AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.

Related views