U.S. Data: Higher Than Expected

Mid Week Bond Update

U.S. Data: Higher Than Expected

U.S. economic momentum is a more tangible reality for markets this week than trade war with China; German bunds continue to flirt with zero, but maybe for not long; Turkey takes effective but unpalatable medicine on interest rates.


“Higher than expected” has been the mantra for U.S. economic data in September – with US jobs, earnings growth and Friday’s industrial production figures all coming in above expectations.

These figures – and not the tit-for-tat in the U.S.-China trade war that has dominated headlines – appear to have had more influence on the markets. Even with the huge expansion of tariffs announced by President Trump on Sept. 17, over the past week the yield on US Treasuries rose between 4-6 basis points along the curve for maturities two years or higher, while the S&P 500 grew over 1% in value.

The relatively flat arc of the yield curve suggests that many investors are expecting continued rate hikes from the Federal Reserve (Fed). However, recent comments made by Jerome Powell, the chairman of the Fed, suggest policy is close to neutral with only limited rate rises to follow. In his recent Jackson Hole speech Powell cited Alan Greenspan’s leadership in the 1990s and how the Fed held off on tightening after seeking but not finding a strong signal on rising inflation – a very similar situation to today. Powell said: “While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating.” 

 

US Treasury Yield Curves: 9/12/18 versus 9/18/18

Source: Bloomberg, as of 9/18/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Rise: German bund yields

At what point will German bunds return to some semblance of normality?

There was no answer to this question in August, when money flowed to the triple-A rated economy as a safe-haven, fleeing concerns about the Italian government busting budget limits to meet election promises. As a result, 30-year bund yields dipped below 1%, while the yield on everything between 2 and 7-year bund maturities was negative.

But bund yields bounced back in September. Fears over Italy subsided and progress on Brexit negotiations dampened fears of the impact on European trade. By September 18, the 10-year bund yield stood at 0.45% after lows of 0.30% a month earlier.

Three factors suggest bunds are not likely to continue this flirtation with zero. First, German yields are pricing in an economic downturn for Europe, but the most recent forecast from the European Central Bank (ECB) is for a slow, but favorable improvement in conditions. Second, European employment and gross domestic product are on the rise and inflation is edging closer to a 2% target. Finally, the ECB’s asset purchase program comes to an end in December which should offer greater yield for investors, while the continued normalization of US interest rates will give greater competition for investors weighing up where to allocate.

 

10-year German Bund Yield vs. 10-year US Treasury Yield (%)

September 19, 2017 - September 18, 2018

 

Source: Bloomberg, as of 9/18/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

 

On the Slide: Turkish corporates and banks

Turkey has curbed the fall in its currency for now, but in the coming months it faces austerity and government intervention to protect its banks. On August 13 the Central Bank of Turkey decisively raised rates from 17.75% to 24%, well above the market consensus of 21%, with the intention of containing the depreciation of the Turkish lira and the sharp rise in inflation to 17.9%. To restore confidence, the Central Bank also signaled that a “tight stance in monetary policy will be maintained decisively until inflation outlook displays a significant improvement.” 

The bank’s actions saw the Turkish lira initially recover around 5% of its value against the US dollar, while 10-year local debt saw yields drop by 8% and USD-denominated 10-year bonds dropped 10% in yield.

The cost of such relative stability will be felt by Turkish businesses which hold significant US dollar debt. Turkish banks, whose capital base has depreciated along with the lira and a rise in non-performing loans, are also expected to suffer. 


All data sourced from Bloomberg unless otherwise noted.

Definitions:

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.

 

 

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