Eurozone, the ECB on the back foot in 2017

In the Eurozone, although base effects and energy prices continue to support headline inflation, core inflation trends remain subdued and are likely to keep the ECB on the back foot for the majority of this year, especially given the heavy political calendar.

That said, once French elections have passed, the next theme for the market to focus on will inevitably be the risk of ECB tapering which reduces the attractiveness of holding EUR duration at this stage, while also supporting a preference for USD IG over EUR IG credit risk. There is a clear argument for US HY as Trump’s most consistent message has involved corporate tax cuts and deregulation which is positive for the S&P, and for which US HY is the closest substitute in credit markets. It is possible also to take comfort and confidence from impressive OPEC compliance thus far, providing support for oil, the energy sector and therefore US HY.

Financial markets remain focused on Donald Trump trying to work out which of his policies he will prioritize and manage to push through now that he has chosen the majority of his cabinet. The increased likelihood of a fiscal package was worth a premium in the US rates market which appears now to have been largely completed, with 2.5 hikes priced in for 2017 compared to the Fed’s forecast of 3 in its median dot plot projection.

In addition, the fiscal multiplier of a Trump stimulus package seems set to be relatively low as it will be directed to corporate tax cuts rather than substantial infrastructure investment which will initially be harder to push through Congress. Such a stimulus mix should only provide a short-term boost to growth, rather than structurally altering the macro backdrop or the potential growth rate of the economy, which is instead determined by factors including productivity and demographics.

Olivier Debat – Fixed Income Investment Specialist – Union Bancaire Privée (Ubp)