Tough Health Check

Mid-Week Bond Update

Tough Health Check

US president Trump’s failure to pass through Congress his planned Healthcare bill increased skepticism over his ability to implement other reforms – and the sustainability of the so-called reflationary “Trump trade.” The reality check lifted US Treasuries, especially those with longer maturities, which had been particularly hit...

since the Nov. 8 election, given the prospects of higher growth and inflation. The US dollar continued its now three-week slide, while inflation expectations receded. US equities ended a tumultuous five-day period recovering previous losses, helped by surging oil prices. West Texas Intermediate oil rose to US$48.5 per barrel, after falling to $47, on the back of Libyan supply disruptions and expected output cuts.

Emerging Markets (EM) bonds extended previous weeks’ gains, helped by a softer US dollar, which makes EM dollar-denominated debt more bearable. The Russian ruble rallied 1.35% against the greenback over the past five trading days, following an unexpected rate cut and also after ratings agency Standard & Poor’s moved its outlook on the country’s sovereign debt to positive from stable. The Mexican peso broke the under-19 pesos per US dollar-barrier for the first time since the US election. The currency has now rallied 16% since Trump was sworn in as US president in late January, narrowing to 3.1% its post-election loss. Spreads of the JP Morgan EMBI index of US dollar-denominated EM sovereign debt fell to 325 basis points, the lowest since 2014. The British pound fell as the UK officially started its exit from the European Union (EU). UK inflation-linked bonds were the best-performing fixed income asset class, among a selected group of 33, over the past five trading days: UK inflation has been running high as a result of the 17% currency drop since the country voted to leave the EU on June 24. The yen, gold and German bunds, traditional safe-havens, all rose.

 

ON THE RISE

Long Treasuries – long race: US sovereign debt with a maturity of at least 25 years gained 0.8% over the past five trading days, one of the best fixed income sector performances. The rise reverses a Trump-trade fuelled negative streak, narrowing the asset class’ 1 and 12-month losses to 0.6% and 5.5%, respectively. But long bonds shouldn’t be ruled out so quickly: in fact, they’ve gained 19.4% over the past 3 years, underpinned by moderate growth and inflation, as well as accommodative monetary policy – all circumstances that haven’t significantly changed. According to some investors, US long bond yields are down only marginally from their levels of ten years ago, even though both inflation and real growth have fallen more sharply over the same period. Also, the current 8-month old long-bond sell-off is already as long as most similar sell-offs in memory. Finally, rate hikes typically lead to a flattening of the yield curve, even inversion, as the front of the curve rises more than the back – and this usually translates into lower long yields. In fact, two of the last three US hiking cycles have delivered declining Treasury yields. As seen in the chart, and since the US November election, longer yields have outperformed shorter-maturity ones. It’s a long race.

 

Believe it or not: Long Treasuries win Trump trade

 

Source: Bloomberg as of 29 March 2017. The second chart illustrates the difference between the two lines in the first chart. Please find definitions in the disclaimer.

 

US homes – an investors’ castle? The Markit iBoxx Broad US non-agency Residential Mortgage-Backed Securities Index was the second best-performing fixed income index over the past five trading days, with a 1% gain that takes its 12-month return to 24%. The asset class has been fuelled by rising US house prices, which in January rose 5.7% from January 2016, above forecasts and the fastest pace since July 2014. US consumer deleveraging, an improving economy and lean inventory are behind the price increase, which is about twice the inflation rate. Surging consumer confidence has also supported the sector: the well-known Conference Board index of Consumer Confidence surged to 125.6 in March, the highest since the year 2000. Click here to read more about the asset class’ traditional higher yields, low volatility and low interest rate sensitivity.

 

ON THE SLIDE

UK-EU ties – divorce begins: As a Eurostar train delivered in Brussels a letter that brings a 40 year-relationship to an end, the British pound continued to slide against the US dollar – a sign that investors’ concerns about Britain’s departure from the EU are far from over. While millions of voters think Brexit will mainly change the country’s immigration policies, financiers are more concerned about trading ties and, mainly, the ability of UK-based financial institutions to continue selling their products in the continent. This is particularly relevant as Britain has relied and still relies on foreign capital inflows to finance its widening current account balance – or the difference between the country’s total imports and exports of goods, services and transfers. This doesn’t seem to be a problem while foreign money flows into the UK, traditionally a safe-haven. Some, however, worry whether cash will continue to pour in after the country’s EU departure. Also weakened by a lower pound, Britain may look a bit more vulnerable, especially relative to Germany, whose current account surplus has swollen on the back of surging exports and tight domestic consumption. Will this change after the German election in September, and as a result of the Brexit negotiations? Read Brandywine Global’s “Around the Curve” blog to learn more about Europe’s present delicate political moment.

 

Capital needs – UK hopes for a Brexit current account twist 

Source: Bloomberg as 29 March 2017. CA is Current Account; GDP is Gross Domestic Product. RHS is right hand side. Please find definitions in the disclaimer.

 

Rand – a president’s rant? The South African rand sank 1.9% against the US dollar after president Jacob Zuma told African National Congress leaders that he wanted to sack finance minister Pravin Gordhan. News reports said Zuma unexpectedly called the market-friendly minister while he was on a roadshow in London, aiming to summon him back. The currency, however, pared some losses on reports of top ruling party officials opposing Zuma’s planned move. The rand is still one the best-performing EM currencies against the US dollar so far this year, up 6.3%, on the back of improving fundamentals, such as a narrowing current account deficit and slowing inflation. Talks are continuing.

 

Source for all data: Bloomberg and Barclays Capital as of 29 March 2017, unless indicated.

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