Florida keys

Mid-Week Bond Update

Florida keys

Global bonds had a positive five-day streak as more terrorism attacks, soft global data and rising geopolitical tension over North Korea built up ahead of a key and first summit between the presidents of the 2 most powerful nations in the world, China and US, in Florida later this week. The mood was...

reinforced by weak US auto sales figures and further US Federal Reserve (Fed) softspeak, which drew inflation expectations lower. In Europe, German March inflation fell to 1.5%, well below expectations of 1.9%, dragging down the entire Eurozone inflation expectations to a five-month low. The euro fell against the dollar as forecasts of an imminent rate hike, which had increased to a year-to-date high of 4.2% due to reduced deflation concerns, fell back to a resolute zero. German bunds and other European sovereigns rose.

Emerging Markets (EMs), however, didn’t participate in the general fixed income rally, as a whole, after South African president Zuma sacked his market-friendly finance minister and reshuffled his cabinet, causing a currency plunge and a sovereign credit rating downgrade. Individually, though, most EM local sovereign bonds gained over the past 5 trading days, led by Brazil and Indonesia. The two oil-exporting countries did well after the commodity surged to US$51 per barrel, from $47 last week, on the back of supply disruptions and hopes of further output cuts. The oil rally pushed US High Yield (HY) spreads lower, as energy represents about 15% of the US HY index. UK government bonds were top winners in the safety flight, given their traditional longer interest rate sensitivity (they profit more as yields fall or lose more as yields rise). This is measured by duration, which in the case of the gilts index is almost 12 years, well above the Eurozone sovereigns’ 7 years or the 6 years of US Treasuries. 


ON THE RISE

Dollar-yuan correlation: Casablanca echos in Florida? For all market volatility and newsprint inches derived from president Trump’s comments about China’s use of its currency as a way to boost exports, hurting US industry, it turns the Chinese currency is one of most correlated to the dollar. Barring the Swiss franc, which as a traditional safe-haven moves almost in unison with the dollar, the renminbi (also referred to as yuan) comes second among a list of major currencies, ahead of traditional stability landmarks such as the Swedish krona, the Japanese yen or the Canadian dollar. On the other hand, those who profit more when the greenback loses are the euro and the British pound, as they are negatively correlated. In fact, and over the past five days, the yuan-dollar correlation reached its highest level since 2011. This correlation, on average positive since 2006, has steadily increased since touching a one-year low in October, just before the US election, as seen in the chart. Louis, is this the beginning of a beautiful friendship? Click here for Western Asset’s views over global bond markets.

 

Greenback – yuan correlation: more friends than enemies

 

Source: Bloomberg as of 5 April 2017. US$ is US dollar. Please find definitions in the disclaimer. 

 

There must be an angel… in my HY account? US HY bonds which have been recently downgraded from Investment Grade status, popularly known as “Fallen Angels,” gained 1.1% over the past 5 trading days, taking their 12-month performance to 23%. The rise was largely driven by oil companies, although risk sentiment improved in other sectors, such as Utilities and Communications, when measured by the price investors pay for protection against default. The “Fallen Angels” asset class traditionally performs well when economic growth is strong enough to generate profits, but low enough to keep interest rates at bay – a positive for financing costs. The HY asset class, in general, was also favoured as US defaults remained very modest in March, with only 2 companies defaulting on $930m in debt. February and March’s combined default activity ($1.4bn) is the lowest since June 2014, according to JP Morgan.

 

ON THE SLIDE

UK external deficit: devaluation works: Britain’s current account deficit improved in the fourth quarter at the fastest pace since 2011, buoyed by exports, which rose more than imports. As seen in the chart, the external improvement followed a weakening of the pound, which makes British exports cheaper abroad. Sterling has plunged 16% since Britain voted to leave the European Union on June 24. The figures also revealed decreasing appetite from foreign investors for UK bonds and equities, countered by an increase in Foreign Direct Investment. However, at 4.4% of Gross Domestic Product, it’s still a long trek before the UK current account balance returns to positive territory – a feat not accomplished since 1986, when Margaret Thatcher was Prime minister. Her successor Theresa May is trying hard: she has visited 19 countries since her premiership began in July last year, including the US, China, India and this week, the wealthy Saudi Arabia. In contrast, the further president Trump has travelled away from the White House is Florida.

 

Pound down, exports up – it works

Source: Bloomberg as 5 April 2017. CA is Current Account; GDP is Gross Domestic Product. RHS is right hand side. USD is US dollar and GBP is British pound. Please find definitions in the disclaimer. 

 

French election TV debate - Le Pain: French anti-euro election candidate Marine Le Pen didn’t fare well in a marathon 4-hour television debate, which included as many as 11 candidates. Centrist front-runner Emmanuel Macron won the post-debate polls, with Le Pen falling to the fourth most-convincing candidate. Le Pen’s previous ascent had unnerved investors on concerns that her plans for a French EU exit referendum could break up the entire European project. French spreads over German bunds fell to 66 basis points following the debate, far from the almost 80 they reached in February, at the height of Le Pen’s popularity. Still, they are well above the 40 basis points level more or less maintained over the past 3 years. The election will be held in 2 rounds, on April 23 and May 7. Click here to read Brandywine Global’s views on the vote.

 

Source for all data: Bloomberg and Barclays Capital as of 5 April 2017, unless indicated.

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