Investor Sentiment: Europe’s Militarisation and EM’s Liberation
What does our institutional investor and PriceStats inflation data tell us about changing European and Emerging Markets landscapes?
Our gauges of investor behaviour in sovereign bond markets help to contextualise German bond yield movements. Long-term investors’ holdings of Bunds were in the 98th percentile of past holdings over the last five years — until news in late February that Germany would be taking its foot off its constitutional debt brake to fund defence spending.
As a result, investors spent much of March attempting to reduce this overweight. Bund selling has only been larger on 10% of occasions in the past five years. But our flow data shows that this selling of Bunds was not reflected across the Eurozone (Figure 1). Demand for OATs, BTPs, and Bonos - French, Italian and Spanish government debt respectively - were all significantly above average in March, which appears to indicate a rebalancing across Eurozone bonds rather than a flight out of the region.
Q2 may bring more macro challenges for the region’s bonds. PriceStats® currently captures a much firmer momentum in inflation, relative to seasonal trends, in the Eurozone than it does in the US.
Local Currency Opportunities Emerge
Demand for emerging market (EM) assets, in particular local currency government bonds, recovered smartly at the end of Q1, despite uncertainty surrounding US growth, trade, and fiscal policy.
This partially reflects investors’ rethinking of the US dollar (Figure 2). Our metrics show dollar holdings peaked on 14 January this year. We have seen steadily consistent and accelerating sales since then with no sign of that appetite to sell diminishing.
Demand for EM local currency sovereign bonds did pause at the end of March after robust inflows in the second half of the quarter. Inflows have been concentrated in Mexico and South Africa, and we saw little contagion from the return of turbulence to Turkish FX and bond markets in March. It appears investors are being selectively more constructive on prospects for EM debt amidst the turbulence in views elsewhere.
EM inflation trends are also supportive in aggregate, but with some divergences. PriceStats captures a reacceleration of inflation in Brazil and, to a lesser extent, Poland so far this year. Both are consistent with weaker institutional investor demand for local bond markets. In contrast, South Africa has seen a much sharper fall in online inflation. Mexican inflation is also drifting lower, supporting hopes for rate cuts in the next six months.