M&G Investments’ bond superstar Richard Woolnough has warned the European Central Bank (ECB) would be “overreacting” by embarking on quantitative easing because the region is already recovering.
Speaking on a webcast today, Mr Woolnough attacked the consensus view that the eurozone is on the verge of a recession or deflation.
He said the monetary policy action undertaken by the ECB in the past couple of years was beginning to filter out into the eurozone economies and the benefits were now being felt even in the peripheral nations.
“I think monetary policy is working and the economy is not as weak and deflation is not as big a threat as the market perceives,” he said.
He said the fall in inflation was due to temporary factors, such as the strength of the euro and a fall in the price of oil.
“Core eurozone inflation is higher and the periphery is lower,” he said. “As the periphery recovers inflation will pick up and will be better than people expect.”
However, the manager said he expects the ECB to embark on some sort of QE and said it would have done so already if it was not so difficult to do within the eurozone legal system.
He said the ECB will embark on QE “because they fear deflation” but he claimed “they are semi-overreacting” and were mistaken in its worries.
The M&G team’s view has meant the £22bn Optimal Income fund has taken a negative duration position in eurozone duration, effectively government debt. This position would benefit the manager if interest rates rise, something which normally erodes returns from bonds.
However, market fears about deflation have pushed eurozone debt yields lower, particularly German bunds, and Mr Woolnough has admitted the position has “hindered” the fund so far this year.
The compression of eurozone government debt yields has led to a dislocation with US and UK government debt that Mr Woolnough said he is looking to take advantage of.
But he said his main focus on the Optimal Income fund was still in the credit market, where he favours investment grade bonds over high yield bonds.
