On the cusp of the tenth anniversary of the financial crisis, and after billions of US dollars, euros and pounds spent to revive global growth, major central bank leaders sent hawkish messages almost in coordinated fashion, a move that could well signal the end of a decade-long stimulus era. From London, US Federal Reserve (Fed) chair Janet Yellen said...
it is appropriate to raise rates, adding that the US economy and its banks are strong, while some assets appear overvalued. In Sintra, Portugal, European Central Bank (ECB) president Mario Draghi mentioned for the first time a potential adjustment of monetary policy, although he tried to tone down his comments the following day. Bank of England governor Mark Carney joined the hawk club by saying that some stimulus removal may be necessary. As a result, yields jumped in Europe and the US and a renewed risk-on mode lifted appetite for traditionally riskier assets, such as High Yield and Emerging Market (EM) debt, which could benefit from a better global outlook.
EMs, also, and according to Yellen, are now better prepared to handle Fed hikes than they were in 2013, when the US central bank first signalled its intention to taper its monetary stimulus, leading to a sharp spike in Indian bond yields (read more below). Mexico led EM local sovereign debt returns over the past five trading days, up almost 1%, taking its year-to-date gain to 7.4%. The country’s bonos and its currency were boosted by a dovish rate hike last week, which was followed by officials’ comments about potential future easing policies. The peso surged to 17.8 units per US dollar, the highest in more than one year. Even the Brazil real strengthened 0.8% against the greenback over the past five trading days, despite press reports saying president Temer had been charged with passive corruption by a prosecutor. Oil reversed a losing streak and surged by almost US$2 to $44.1 per barrel on expectations of increasing demand.
ON THE RISE
EMs resilience – shrugging off Fed hikes? EMs are now more resilient to rising rates in the US, Fed chair Yellen told a London audience this week. Speaking at the British Academy, Yellen cited the spike in Indian bond yields in 2013, when her predecessor Ben Bernanke first signalled the central bank’s intention to taper its monetary stimulus. The episode is known as “taper tantrum” and led to a public spat between Bernanke and his then Indian counterpart Raghuram Rajan. Stiller waters seem now in place: as shown on the chart, Indian rates have barely reacted to the last three Fed hikes, being contained by the country’s improving inflation outlook. Helped by low oil prices, India’s price stability has improved, leading the central bank to cut its inflation projections earlier this month. Expectations of further rate cuts have increased demand for Indian sovereign local debt, which has gained 2.4% over the past 30 days. Apart from improving fundamentals, Yellen said the Fed is very aware of any spill-over effects of its policies, which the central bank tries to minimise by regularly meeting EM central bank governors.
India and Fed hikes: from shock to yawn
Source: Bloomberg as of 28 June 2017. RHS is right hand side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.
Euro – rising from the dead: The European currency surged 2.1% against the US dollar over the past five trading days, mostly after ECB president Draghi said the dark days of deflationary fears seem over, showing increased confidence in the region’s outlook. Although he tried to temper market speculation about a potential tapering of the stimulus in place, the European currency and sovereign bond yields continued to signal a future policy change. European data has improved and the region is also sorting out some of its ailing banks: in Spain, two small and troubled lenders have been recently acquired by bigger and better capitalised rivals, while Italy injected state aid into two regional financial institutions. Hopes of faster growth and a better banking system have lifted five-year inflation expectations in five years’ time to 1.56%. Still far below the ECB’s 2% target, but an improvement from 1.50% only last week.
ON THE SLIDE
US curve goes flat: economic woes or yield refugees? The difference between 30 and 10 year US Treasury yields reached this week the lowest level since January 2009 – traditionally a reflection of poor inflation expectations. Lacklustre data has led some investors to question the Fed’s rate hiking path and the central bank’s dismissal of recent poor data as temporary. Backing this sceptical view, the International Monetary Fund cut its US growth forecast this week to 2.1%, from 2.3%, as it removed previous assumptions of president Trump’s planned tax cuts and infrastructure investments. As shown on the first chart, the curve flattening has also mirrored oil prices, whose drop may not be only due to demand concerns. The second chart suggests that supply issues could also be behind the recent plunge in oil: despite the output cuts from the Organisation of Petroleum Exporting Countries (OPEC), US shale producers have increased the number of rigs they operate, offsetting the effect of the OPEC cuts and helping depress prices. Additionally, US long-term yields are also kept at bay by demand from European and Japanese investors, who face lower yields, sometimes even negative, at home – turning them into yield refugees.
US yield curve – a game of oil?
Source: Bloomberg as of 27 June 2017. WTI is West Texas Intermediate oil. UST is US Treasury. RHS is Right Hand Side. Please find definitions in the disclaimer.
Retail – on sale: The US High Yield retail sector is lagging behind its Consumer Cyclical sector peers so far this year, in which it has stayed virtually flat. In contrast, Home Construction, Services and Restaurants have gained 6.5%, 5.3% and 4.3%, respectively, a sign of investors’ faith on the country’s improved economic outlook. Retailers, however, may not be able to capitalise on the growth as consumers are spending more online, leaving traditional brick-and-mortar shops and malls emptier and more vulnerable to acquisitions. In an industry landmark deal, a major online retailer announced earlier this month plans to buy an upscale grocer. The move pushed down equity prices of rival retailers on expectations that the grocer’s products would be now more competitive and available online.
Source for all data: Bloomberg and Barclays Capital as of 28 June 2017, unless indicated.