The European Central Bank is sitting on a ‘knife edge’ between deflation and price stability, according to PIMCO’s Andrew Bosomworth.
The Munich-based manager, who runs two European bond funds, said he is positioning for potential quantitative easing by the euro area central bank.
Ahead of the monthly policy meeting in Frankfurt this Thursday, ECB President Mario Draghi has maintained the stance that the eurozone is not experiencing deflation, but the central bank will remain alert to downside risks and act if necessary.
‘The ECB is sitting on a knife edge between a deflationary environment and a stable environment,’ Bosomworth, who is head of PIMCO portfolio management in Germany, told Citywire Global.
‘The area is still very vulnerable to external shocks and I think we may see an asset purchase programme this calendar year.’
Bosomworth said he does not expect quantitative easing to be announced at the coming meeting, as economic data is still not sufficiently weak to warrant fresh stimulus. However, he said he expects markets to start pricing a move in.
This time it’s different
Besides government bonds and loans issued by banks, covered bonds are also likely to be added to the potential mix of asset purchases by the ECB, said Bosomworth.
‘Covered bonds would be a safe asset for the ECB to purchase and the ECB would also be making a point to support the underlying loans issued by banks,’ he said, adding that nearly a third of the portfolio is in covered bonds.
Bosomworth's portfolio, which includes the PIMCO GIS Euro Low Duration Inst fund and the PIMCO GIS Euro Short-Term Inst fund, has added around 5% in covered bonds since last quarter and has continued to add.
Other managers, such as BlackRock’s Michael Krautzberger, have also forecasted quantitative easing by the ECB but with certain conditions - such as providing incentives for banks to lend to smaller businesses.
Conditions on asset purchases or targeted bond purchases, according to Bosomworth, would not be likely in a deflation-targeted quantitative easing programme.
‘We think that the ECB would buy the government and covered bonds across all countries according to a country’s share of GDP, i.e. according to the ECB’s capital key,’ said Bosomworth.
‘The issue has moved on from keeping the euro together to whether deflation is the problem or not. As with le roi est mort, vive le roi, what we may come to hear is "the OMT is dead – long live quantitative easing".’
Under a GDP-weighted programme, German government and covered bonds would probably make up around 27% of the total assets purchased, he added.
‘For this reason, while we are not excited by low-yielding bunds, we wouldn’t like to be short them either,’ he said.
Bosomworth said that whilst quantitative easing is not certain, the markets are likely to price it in regardless, providing support to higher yielding assets.
‘We are selling anything that is lower yielding, including, for example, some government bond and Danish flex loans,’ he said.
‘If we would start hearing from Draghi more about downside risks to inflation, we would start positioning our portfolios towards assets that we think the ECB might buy in an asset purchase programme as well as riskier and less liquid assets that would benefit from additional liquidity.’
The bond investor has continued to add Slovenian government bonds but is still cautious on Portuguese bonds for the moment.
Andrew Bosomworth has returned 7.94% over the last three years to the end of January through the management of the PIMCO GIS Euro Low Duration Inst fund and the PIMCO GIS Euro Short-Term Inst fund. The average return in the Bonds - Euro Short Term sector tracked by Citywire, was 7.5% for the same period.