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‘US downgrade is warning shot for the future’ – Henderson Global Investors' CIO

Henderson Global Investors' CIO, David Jacob, talks to Euromoney about policymakers creating rather than stemming market volatility, investor safe havens and how the US downgrade has affected the dollar’s future as a reserve currency

As a raft of mixed economic data drives markets into a new state of volatility, investors are seeking safe asset class havens amidst the turmoil.

Euromoney speaks to David Jacob, chief investment officer at Henderson Global Investors, on market sentiment, crucial data points in the calendar, and how policy makers are hindering market recovery and creating volatility.


Since 2008 governments around the world have become more involved with the financial markets in terms of policy making. You have mentioned the US, do you think the raft of policies across Europe are helping or hindering the market?

I have been saying for a while that governments are now more interventionist than has been the case before, as well as at a different magnitude. That point is a large part of the volatility we see. We are continuously speculating on what governments are doing, going to do, or going to say. For example, markets wait to watch and hear what Merkel says about issuing Eurobonds, what the UK government will say on austerity, what Bernanke or Obama will say in upcoming speeches, and their willingness to throw firepower in monetary and fiscal stimulus terms.

The Federal Reserve balance sheet now stands at $1.6 trillion while long-term historical levels were more like $9 billion, so we are seeing expansion by a factor of 200 by the Fed. A third round of quantitative easing – QE3 – is a possibility, but I am not convinced that it can actual solve any of the markets problems as we are likely to be in a liquidity trap. Banks do not need cash as they do not have the credit problems of 2008. 


Equity markets are still down 10% to 20% despite the short rally over recent days. What is driving this volatility, especially in terms of economic data?


Market volatility shows weak economic data from developed countries, but some positive data coming out from China has given the market some heart, as the developing world is continuing to grow in this environment, which I believe will benefit the west. I continue to believe that the best we can hope for is a slow growth environment.

The outlook is difficult for consumers, as they are faced with not very good news. Jobs are being cut, taxes are going up, governments are calling for austerity and we are all facing inflation. The recent turmoil will further heighten the nervousness of consumers and spending is likely to be pulled back further. This increased uncertainty will also create wariness in corporates leading to a difficult earnings season ahead. 

David Jacob, chief investment officer at Henderson Global Investors

August is a difficult month to get a proper feel for the corporate sector and the markets, as thinness in liquidity terms can get amplified in the quieter months. However, in September, data will become more reflective of true economic reaction. The next earnings season will be interesting as there will be definite markdown in results and the question will be about the severity of the numbers. I think analyst expectations are still too bullish and the correction to earnings numbers will come shortly.

There are several sets of data coming out of Asia that might drive optimism, as well as news from Bernanke at Jackson Hole and Obama’s upcoming speech. Despite the US downgrade, there is an expectation on fiscal easing coming out of that speech, and equity markets are looking for a reason to strengthen. With regard to bonds: credit markets are extremely poor at the moment, spreads on financial securities are as wide as during the crisis and the bond market has obviously not caught the low-grade excitement like the equity markets. 


In terms of fixed income, bond yields are also down and are said to not to be providing much in terms of return. Is it a safe asset class?

Government bond levels are pretty poor at the moment and unless there is a depression, owning government bonds at these levels would not be attractive. That said it is very difficult to be in this environment and short these bonds. It may sound strange, but actually corporate bonds are a safer haven for investors at the moment as spreads are at an attractive level, although they may face further volatility in the future, while spreads in financials have widened to the levels of when the crisis happened. I don’t think the corporates are as leveraged, or in a delicate position in inventories as in 2009, and they are healthier overall. I would not be adverse to owning these bonds over the medium term at these levels but very wary of being long duration. 


How has the downgrade affected investor sentiment towards bonds, particularly treasuries?


The outcome in terms of US cost of capital has been nothing, if not irrelevant and none of the facts have changed. Relative to the other triple-A countries at the moment, the US stands out, but other triple-As are arguably more fragile. It’s important not to get caught up in the downgrade itself, but the downgrade is an interesting signal or warning shot for heralding two things that US should pay attention to.

Firstly, the US needs to get its fiscal house and political house in order and the farce with the debt ceiling had an outcome that everyone expected. The market was essentially subjected to a parody of politics in the run up to it – it was a pre-election stance-taking manoeuvre. The US has to take its fiscal position seriously; with the fiscal tool bag empty further fiscal stimulus would be difficult to use to support the economy.

More subtle in the long term, is the threat of the dollar relinquishing its position as the world’s reserve currency. The willingness to downgrade the US begins to create a world where it is possible that the dollar will not be the world reserve currency. China is increasingly interested in the erosion of reserve status of the dollar and it will be quick to suggest new alternatives. If the US can’t get its political stage in order, this maybe a possibility, as the downgrade is a symbolic warning shot for the future to come.

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