After much anxiety about a quick pick-up in US growth lifting bond yields, most global bond markets rallied over the past five trading days as optimism faded, dragged down by some dovish Fedspeak from current chair Janet Yellen – and by the appointment of a successor whom markets expect to be as cautious as her. Despite rising oil prices, US inflation expectations...
fell as yields also dropped, led by long-maturity Treasuries – which tend to outperform as investors seek a lower risk and inflation premium in the future.
The US dollar extended its early November drop, favouring Emerging Market (EM) currencies, which also gained on the back of improving fundamentals: the South African rand soared 3.4% over the past five trading days on speculation president Zuma might be pulling out of the African National Congress’ leadership race, while in Brazil, the real strengthened 2.1% against the US dollar on increasing investors’ hopes that the Social Security Reform might be approved, helping relieve the stretched country’s coffers.
ON THE RISE
High Yield dispersion – cherry picker’s market? After a 20-month, 486-basis points spread rally, the US High Yield market had a bad patch in early November as investors speculated spreads could not get any lower and rising growth might generally hit fixed income investments. The asset class, however, turned around last week and spreads tightened again on expectations that the current mixture of rising growth and accommodative policy will persist. This scenario is usually referred to as High Yield’s sweet spot as growth is enough to drive corporate earnings higher, but low enough to keep rates – and defaults – low. What has increased, though, as the credit cycle matures is the spread dispersion within the asset class, or the varying difference between index members’ spreads over benchmark Treasuries. As seen on the chart, this dispersion has increased especially in the US, where the credit cycle is more advanced than in Europe. Such dispersion highlights the importance of selection for investors seeking High Yield’s traditional higher income. Click here to read Brandywine Global’s Around the Curve blog: Are there still opportunities in Global High Yield?
Dispersion – the mother of selection?
A higher coefficient of variance means selection is key to pick potential winners
Source: Bloomberg Barclays Capital 22 Nov. 2017. The High Yield indices used are both the Bloomberg Barclays High Yield indices for the US and Europe (EU). The scale used is the Coefficient of Variation (standard deviation / mean). Past performance is no guarantee of future results. Please see disclaimers for definitions.
Emerging Markets – Powelled: Most EMs and their currencies gained over the past five trading days, as US president Donald Trump’s picking of Jerome Powell to succeed Yellen as Federal Reserve (Fed) chair led investors to speculate that the protracted accommodative policy is not reversing at any time soon. The positive mood over the asset class was also backed by fundamentals – including a ratings upgrade of India, by Moody’s, which sent the rupee higher. The JP Morgan EMBI Plus index of US dollar-denominated sovereign spreads over Treasuries, fell to 346 points, after rising to 355 two weeks ago – the highest since January.
ON THE SLIDE
Swaps and Treasuries – swapping positions: Market anomalies can mean-reverse, some analysts say – and what has been seen in the Treasuries vs swaps market may be such: as US government debt usually bears a low yield because it is backed by the world’s No. 1 economy, any costs associated with borrowing from any other party is seen as a bit riskier. In this sense, the swaps market (where banks and companies exchange funds) used to charge a rate over that of Treasuries. Abnormally, this changed about two years ago, when Treasury yields started trading above the swaps rate. Market participants have cited many fundamental and technical reasons for this (issuance levels, indexing, tougher bank regulation etc), but the trend has now reverted. As seen on the chart, the two lines have now almost converged – a more normal picture. The situation was also enhanced as US yields have been held by persistently low inflation, providing an attractive trading opportunity for those who spotted the trend. Click here to read the views of Western Asset’s Chief Investment Officer Ken Leech over the persistence of low yields, the new Fed chair – and what opportunities might be available in the present environment.
Banks vs government borrowing – back to normal
Source: Bloomberg as of 22 Nov. 2017. The swaps line illustrates 10-year borrowing costs between financial institutions. The US Treasury curve illustrates US Treasury 10-year yields. RHS is Right Hand Side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.
US inflation expectations - anchored: Despite corporate optimism about future US rate cuts and continuous equity market records, US inflation expectations remain anchored – with the 5-year rate falling this week under the 1.8% level again. The index has not surpassed 1.9% since April – still below the Fed’s 2% target. While the lack of inflation momentum is due to cyclical or structural issues is subject to much debate, long-term US Treasuries continue to gain: US government bonds with maturities of more than 25 years rose 1.4% over the past five days, taking their 12-month return to 7.9%.
Source for all data: Bloomberg and Barclays Capital as of 22 November 2017, unless indicated.