European bonds uncork the champagne

Mid-Week Bond Update

European bonds uncork the champagne

European corporate bonds led a global fixed income rally over the past five trading days, boosted by waning anxiety over the French election and strong regional growth. US Treasuries and corporate debt also gained as continued lacklustre data kept expectations that the domestic rate rising cycle will be slow and gradual. This time, it was...

Gross Domestic Product that disappointed, rising to an annualised 0.7% in the first quarter, well below expectations and mostly dragged down by the worst quarterly consumer spending print since 2009. The US Federal Reserve (Fed), however, said the blip could be temporary and left unchanged its plans to lift rates twice more this year. It already raised them in March. The benchmark US Treasury 10 year yield jumped to 2.33% after the Fed's statement on Wednesday, from 2.28% earlier in the day.

European sovereign bonds delivered negative returns over the past five trading days as the euro-area economy grew 0.5%only in the first quarter, raising speculation that the European Central Bank (ECB) might start soon reining in its monetary stimulus. ECB chair Mario Draghi acknowledged an improvement in economic conditions but reiterated his commitment to the expansionary stance. Some investors speculate this may change after Sunday’s French election, in which centrist candidate Macron is expected to beat anti-euro leader Le Pen, according to the latest polls.

Emerging Markets gained as global risk fears waned following the first round of the French election and also after US president Trump said he is open to meet North Korea’s leader Kim Jong Un, a step which could reduce tensions over the nuclear weapons programme of the Asian country. Local sovereign bonds of Colombia, Russia and Brazil rose more than 0.5% over the past five trading days, following recent rate cuts in the three countries. Sterling continued the rally against the US dollar it started on April 18, when prime minister Theresa May called a general election; polls say her lead is substantial, which could strengthen her position as Britain negotiates its exit from the European Union. Oil plunged to US$ 47 per barrel on the back of increased US output.


European High Yield – bon appétit! European High Yield (HY) spreads fell to 324 basis points over the risk-free benchmark index, the lowest in more than 2 years, buoyed by waning fears that anti-euro candidate Le Pen could win this week’s French election and push the country out the European Union. Such anxiety dwarfed European non-financial HY new issuance to 6.6 billion euros in April, half the level seen in March. Investors now expect the new sales’ flood gates to open wide on Monday, following the French vote. The sector’s sentiment has also improved on the back of stronger data: Euro-area manufacturing activity rose to 56.7 in April, the fastest pace in six years. So far in 2017, the asset class’ returns are led by refining and insurance companies, although more cyclical industries such as restaurants and construction machinery are up 4.6% and 4.4%, respectively. The recent rally has taken European HY’s year-to-date return to 3.4%, narrowing its gap with US HY, up 4% over the same period.


European HY - buoyed by lower political fears and strong data

Source: Bloomberg as of 3 May 2017. EU is Europe; HY is High Yield; OAS is Option Adjusted Spread; RHS is right hand side. Please find definitions in the disclaimer.


US homes - strong foundations? Despite unconvincing US data, the US home sector continued to rally, with the S&P CoreLogic Case-Shiller home price index rising  0.7% in February and 5.9% year-over-year. New-home sales for March came in at an annualised rate of 621,000, above estimates of 588,000 - the largest annualised print since July last year and second largest gain since 2008. The sector has improved as the US consumer has deleveraged since the 2007-08 financial crisis, and also as the domestic economy has returned to growth. The Markit iBoxx Broad Non-Agency Residential Mortgage-Backed Securities Index added 0.6% over the past five trading days, taking its 12-month return to 25% and its 3-year gain to 54%.



Yen – gravity forces: Japan’s currency fell to its lowest level against the US dollar since March as global geopolitical tensions in France and North Korea waned, reducing demand for perceived safe-haven assets. As seen in the chart, the Asian currency has closely tracked the world benchmark US 10-year Treasury yield, probably the world’s top refuge in times of trouble. The correlation between the two has also risen to 0.7, the highest since 2010, as shown in the second chart. Despite global sentiment, some investors believe the yen is pressured by the Bank of Japan’s monetary stimulus programme, once again recently reassured by governor Kuroda. Japan has spent two decades trying to revive its deflationary economy, and may still have some battles ahead: Industrial Production fell 2.1% in March, while consumer prices, excluding fresh foods and energy, dropped 0.1% also in March, dragged down by falling communication services.


Yen - Treasuries: safe-havens get closer together 

Correlation shown in second chart

Source: Bloomberg as of 3 May 2017. Yr is year. The second chart shows the correlation between the two.


Oil - oily: The commodity plunged to US$ 47 per barrel, down from $53 last month, on concerns that increased US shale production is more than offsetting the output cuts from other major producers. The Baker Hughes US Crude Oil Rotary rig count has steadily increased since May last year, shortly after oil fell to a 15-year low of $24. Since prices started to recover the number of US oil rigs in use has jumped to 697, after falling to 316 in May last year. Oil prices have also been contained by a slowdown in China and by the slow recovery in the US economy. Relatively low energy prices are also keeping inflation expectations at bay, globally.



Source for all data: Bloomberg and Barclays Capital as of 3 May 2017, unless indicated.



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