Last week, on March 10th, gamers all around the world celebrated Nintendo's “Mario Day”, abbreviating the date to MAR10. Coincidentally, the same day, markets were focused on a different “Super Mario” as they awaited a difficult ECB meeting.
A year ago, the ECB launched QE and has since spent EUR 700bn (or EUR 60bn per month) on bond purchases and has cut rates to boost inflation. Unfortunately neither policy has been effective enough; inflation actually slipped back into negative territory in February, on an annualised basis. Last week the central bank announced: a cut to its benchmark interest rate to zero from 0.05% (a marginal ‘tax’ reduction for banks); the expansion of QE to EUR 80bn a month (more than the EUR10-15bn expected by the market) and a further slice to its deposit rate by 10bps to -0.4%, effective this week. At Draghi’s press conference, he stated that although he does not anticipate further cuts “new facts could change this situation”.
Having previously failed to deliver to the market back in December, this time round the ECB gave the market more than it had bargained for. Following the press conference, the euro embarked on a bit of a rollercoaster ride. Having dropped to a low of 1.0822 shortly after the ECB announcement, the euro rallied strongly to 1.1218, before ending the week at 1.1156, a gain of 1.4% over the week.
The market reaction raises the question as to whether central banks have reached the limits of their abilities to manipulate exchange rates. After the Bank of Japan adopted negative rates on excess reserves earlier this year, the yen rebounded from an initial sell-off. Year to date, the yen has rallied 5.6% against the dollar and 8.2% against sterling whilst the euro has gained 2.7% and 5.2% respectively.
The five countries with largest current account surpluses in absolute terms include two from the eurozone, Germany and Holland(!) plus Japan. These surpluses have risen steadily, and largely unnoticed, over the past 5 years. The combined current account surplus for the five largest surplus nations (the other two are China and Korea) has risen from USD 594bn in 2011 to a projected USD 918bn in 2016 (according to the IMF).
Such large surpluses cannot continue indefinitely. The other side of this equation is that the rest of the world continues to amass significant further debts on top of already outsized liabilities. It would make more sense, from the point of view of global rebalancing, for these currencies to see appreciation.
This is particularly true in the case of the renminbi which has defied most press commentators having gained 1.3% against the dollar and 3.8% against sterling this year. As the euro and yen represent around 40% of the renminbi basket, further gains in the yen and euro are likely to be reflected in further renminbi strength. In our view, a steady decline in the dollar looks the most likely scenario for this year and helps underpin our view of a strengthening renminbi over the course of 2016.
Which is why we remain very optimistic about the prospects for our renminbi bond fund. Already the original fund is up the 4.2% in dollar terms so far this year and 7.5% in sterling. With investment grade bonds still trading at very wide spreads, the prospects for future gains looks quite encouraging.