In the November edition of Financial Investigator, Mary Pieterse-Bloem, Professor of Financial Markets at Erasmus School of Economics and Global Head of Fixed Income at ABN Amro, shares her vision on the consequences of the global pandemic for investors and financial institutions.
Since COVID-19 emerged on the world stage, governments and banks have been adapting to a new situation, in which it is doubtlessly necessary to stimulate the economy to prevent further damage to be incurred. These aid measures influence fixed income portfolios, since these are prone to changes on the financial markets. According to Pieterse-Bloem, the protective function of safe bonds have decreased; in other words, its airbag-function has dwindled. ABN Amro distinguishes two functions for fixed income: to preserve capital and to yield higher returns with higher risk. Because of the global pandemic, yields have decreased, causing even the safe part of a portfolio to yield more negative returns on investments. In order to maintain portfolio diversification and thereby minimise risks, Pieterse-Bloem explores the possibilities of alternative fixed income. One of the main categories that is being investigated, is private debt. Since banks have withdrawn from private debt, it has become more diverse, making it a more promising sector.
Furthermore, Pieterse-Bloem notices that these private investments are frequently linked to projects concerning infrastructure and renewable energy. This makes the professor all the more enthusiastic for these opportunities to further invest in durable investments, since this further enables her to combine finance with the bigger picture and intellectual challenges. She recently conducted a very promising research on this topic with a fellow professor from the University of Oxford, linking private investments to Environmental, Social and Governance (ESG) goals.
Amidst the global pandemic, Pieterse-Bloem noticed a decline in the tradability of government bonds. This is peculiar, since government bonds are regarded as very safe investments. According to traders of ABN Amro, this was caused by the mere frequency of seismic events: fiscal policy changes, lockdowns and monetary easing were some of the aforementioned events. Traders aren’t eager to quote trades they regard as being risky, so supply of government bonds declined.
One of the other factors to impact liquidity is the implementation of buy-back programmes by central banks. Pieterse-Bloem studies the influence of the ECB on liquidity in her capacity as professor: the answer can easily be imagined. Traders are aware that a major player is active in a market, resulting in a certain skewness when prices are indicated. The question is whether the ECB is conscious of the side-effects of its policy.
Current policy and its anticipated effects on the financial markets
Due to COVID-19, we have entered a new stage of quantitative easing, supplemented with the aid of governments putting fiscally stimulating policies in place. Central banks and governments are thus collaborating to sustain the economy. This leads debt ratios to worsen, in some instances to alarming levels. Naturally, this will impact the development of the financial markets. Interest rates are expected to stay at a low level. This is in fact almost irreversible, since a higher interest level would be devastating to countries with high debts. One of the main concerns is the outcome of these rising debt levels: the ECB intends to facilitate the deleveraging of debts, but this system is not infallible. If debt levels prove themselves to be too high, there will have to be a party of creditors that won’t see part of their money back. One of the possible solutions considered, is to have the European Stability Mechanism (ESM) issue Eurobonds. This way, stronger EU-countries vouch for the weaker ones. However, structural reform will be necessary and demanded. If long-term interest rates can’t be contained by means of current instruments, Pieterse-Bloem is convinced that Europe and the United States will apply yield curve control. This would involve central banks buying and selling bonds in order to achieve a certain target rate.
Lastly, Pieterse-Bloem mentions the fact that certain industries are suffering more than others. This can be compensated for by investment projects with the intention of developing infrastructure and alternative energy. These measures would be a double-edged sword, since this would make the agreements as laid down in the Paris Agreement more attainable. Governments will probably issue Green Bonds to finance these projects. This would imply a greater supply of bonds, obviously available at a low interest rate.