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A crash in global bond markets is the biggest fear among fund managers, as the European Central Bank (ECB) prepares to ‘taper’ quantitative easing and the US Federal Reserve looks to unwind the huge portfolio of bonds on its balance sheet.
A net 28% of investors named a fixed income collapse as the biggest risk to markets in Bank of America Merrill Lynch’s global fund manager survey conducted in the week to 13 July.
Managers are on the alert over the plight of bonds as central banks prepare to take away some of the stimulus that has supported them in recent years.
In the eurozone, the ECB is expected to start reducing the amount of bonds it buys under its ‘quantitative easing’ scheme.
Eurozone bonds have already been subjected to a sell-off after ECB president Mario Draghi last month highlighted a ‘strengthening and broadening recovery’ in the eurozone and said reflationary forces could allow ‘adjusting the parameters’ of stimulus.
Even a much more dovish message from Draghi last week, when he argued a ‘very substantial degree of accommodation’ was still needed to boost inflation, has failed to calm fears over the ‘tapering’ of quantitative easing.
‘Investors expect eurozone inflation to rise and find monetary policy too stimulative, putting the ECB’s signalling powers to the test,’ said Ronan Carr, European equity strategist at Bank of America Merrill Lynch.
The US Federal Reserve, which is much further down the line in moving away from stimulus, having sparked the first ‘taper tantrum’ in 2013 when it started reducing bond purchases, is meanwhile facing up to the prospect of reducing its $4.2 trillion bond portfolio built up under quantitative easing.
The risk of the Fed getting this wrong, or the ECB mismanaging tapering, is fund managers’ second biggest fear, with 27% naming a central bank ‘policy mistake’ as the biggest risk to markets.
‘Fund managers’ biggest fears are a shock coming from bond markets or central banks,’ said Michael Harnett, chief investment strategist at Bank of America Merrill Lynch.
The investor survey also highlights how the ‘Trump trade’, the market rally fuelled by expectations of higher growth under US president Donald Trump’s plans of tax cuts and infrastructure spending, is flagging.
Just 41% expect an increase in corporate profits as a result of Trump’s policies, the lowest level since the US presidential election last November.
This follows Trump’s failure to implement healthcare reforms, which has raised questions over his capacity to enact the other aspects of his agenda.
Fund managers’ allocation to US equities has meanwhile fallen to net 20% ‘underweight’, in other words 20% less than the market weighting. This is the biggest underweight since January 2008.
Investors are also cautious over technology stocks, as the US tech sector last week surged past its dotcom bubble peak. Over two-thirds of fund managers described tech stocks as ‘expensive’, while 12% believed they were trading at ‘bubble-like’ valuations.
Despite that caution, technology has been the most ‘overweight’ sector for fund managers for 80% of the time since the financial crisis. But it was knocked off the top this month by banks, as investors anticipate a boost to the sector from higher interest rates.