FROM a macroeconomic standpoint, the ramifications of the UK voting to leave the European Union (EU), or Brexit, might not be as severe as feared.
Still, Amundi Asset Management head of macroeconomics Didier Borowski says the “uncertainty shock” is not going to make things any better for the world, which had been struggling to register growth even before Britons cast their vote in the EU referendum on June 23.
“I think it’s important to understand that we have entered a world of sluggish growth and low inflation, where central banks are trapped in their quantitative easing (QE) policies, and where the equilibrium level of bond yields has dropped significantly,” he says in an interview with The Edge.
“The period from the early 1980s to the global financial crisis in 2008 was an exception; we are not going back to that kind of growth. If your definition of ‘normalisation’ is ‘we should go back to that period’, you would be making a huge mistake.”
As he is attached with a European asset management firm, Borowski knows the pain that fund managers in the continent are going through to seek returns. European bond yields have fallen into negative territory and a “political discount” attached to with the continent’s equity markets will linger for a while. The US, meanwhile, is reaching the end of its economic cycle, he thinks.
“A diversification process is taking place, and we believe this will take time because if you look at the structure of portfolios in major advanced economies, it does not reflect the rising share of global GDP of emerging countries,” he says.
With rising political risks in major advanced economies, emerging markets’ risk-return profiles have suddenly become more attractive to European fund managers, Borowski says. Yet, Amundi no longer views all emerging markets as interchangeable.
Borowski says Amundi reviews its investment decisions on emerging markets on a country-by-country basis and as often as every month. “We are overweight on certain emerging countries and underweight on certain others. It’s also not the same asset allocation on the equities side as it is on the fixed income side.”
The different views on one country’s asset classes can be seen in Amundi’s asset allocation in July. While its equities portfolio is overweight on South Korean stocks, the firm preferred to short the Korean won.
Apart from South Korea, emerging markets that Amundi was overweight on were India, Thailand, Peru, Europe, the Philippines and Russia — “where we’ve been looking at since the beginning of this year”, Borowski says. The firm was neutral on Indonesia and Brazil, although he says that there are European fund managers who have been buying the latter’s bonds.
Malaysian equities, however, are rated “underweight” by Amundi, joining Taiwan, Greece, South Africa and China.
Borowski thinks that with Brexit, it is high time for investors to move away from “the epicentre of political crises and diversify their risks towards other asset classes”. This, however, does not mean that Brexit is going to result in a big dent on the UK economy, much less the world.
“We should not underestimate the resilience of the British economy,” he says. “We do believe the UK is likely to fall into a technical recession by the end of the year. We expect business investments to clearly be in negative territory, households’ savings rate to increase and the housing sector to be under pressure.
“But we expect the economy to rebound next year. The Bank of England will probably cut rates aggressively in the coming months. And we expect the government to implement a fiscal package and lower the tax rate,” he says.
In fact, Amundi revised downwards its global GDP growth for next year by only 10 basis points to 3.1% as at July 20. Developed markets, meanwhile, should grow 1.4% in 2017, just 20 basis points lower than its previous projection.
This, however, compares with its post-Brexit GDP growth assumption of 0.2% for the UK next year, against the 2% Amundi previously projected.
What Brexit begets instead is political uncertainty — “a poison for confidence, and thus, the longer it lasts, the higher its impact on growth will be”, says Borowski. Much of the “uncertainty shock” is contained within the UK, which will affect domestic demand, hence Borowski’s expectation of monetary and possibly fiscal intervention to revive the GDP.
But the EU’s political scene is also causing jitters among investors, just like in the US come November when Americans vote for Republican Donald Trump or Democrat Hillary Rodham Clinton as the next president. In October, Italians will vote in a referendum on constitutional changes aimed to reduce the Senate’s powers and end the bicameral system.
“There is a likelihood that Italy’s Prime Minister Matteo Renzi will resign if the referendum goes through,” Borowski says. Elsewhere, many EU members will hold elections next year.
“Deflationary or disinflationary pressure will intensify against this backdrop; central banks then are going to be more accommodative. What this means is that bond yields will remain under pressure,” he explains.