Higher Yields: Here, There... But Not Everywhere

Mid Week Bond Update

Higher Yields: Here, There... But Not Everywhere

Look beyond the 3 percent yield on the U.S. Treasury 10-year and you’ll notice rates are up elsewhere as well...


... The Bloomberg Barclays Global Aggregate Bond Index Yield to Worst just rose to 2% (as of May 14th), well above its one-year low of 1.47% on September 7, 2017. Just about all major 5-year sovereign yields are higher than their end-of-2017 levels.  The exceptions are the countries that are normalizing after crises such as Spain and Greece.

Nominal rates in the U.S. are on the high end of the global norm, attracting short-term capital flows and pushing up the dollar.  Reasons for the disparity include differentials in growth rates, inflation, central bank independence and trade dynamics; the mix changes minute by minute. Contrast, for example, rates for 5-year European sovereign debt: Switzerland and the Netherlands are at -0.457% and ‑0.187% respectively, while U.K. and Italy are at 1.199% and 0.774%. Germany’s rate is effectively zero (0.005%).

In Asia, Japan’s 5-year rate is -0.103%, while Australia and China are at 2.2427% and 3.395% respectively.

The distressed economies of Brazil, Argentina and Greece have 5-year U.S. dollar debt at 4.300%, 6.682% and 3.092%. Argentina and Turkey are the unfortunate winners in EM local currencies, at 22.99% and 15.59%, respectively.


Five-Year Benchmark Yields, 5/5/2018

Source: Bloomberg, May 15, 2018 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: U.S. corporate profits come home

One of the successes of the new tax law: the erasure of the advantage to U.S. companies of keeping foreign-earned profits from coming home to the U.S. Cash associated with those profits has indeed started coming home, showing up in several corners of the market.  U.S. institutional prime money market funds are one such corner. The U.S.-based Investment Company Institute notes that in the week ended May 9, a net $8.1 billion flowed into these strategies, the most since mid-2016. Prime funds invest in very short-term corporate and related debt, and generally have a slightly higher yield than funds that by charter are restricted to government securities. The timing tells a tale; total assets in prime funds is now at about $204 billion, the most since September 2016, one month before money market reforms went in effect in reaction to a high-profile fund “breaking the buck”[1] and slowing redemptions in 2008. More than $800 billion fled prime funds in advance of the change in regulations, eight years later in 2016, headed toward funds investing in government securities.  By Nov 2, 2016, these funds were down to $122 billion in assets according to the ICI.

[1] Most money market funds in the U.S. held per-share net asset values at exactly $1.00. When redemptions made it impossible to hold the value at $1.00 without capital infusions, funds that couldn’t maintain that NAV were said to “break the buck”.


Prime Money Market Fund Assets (Institutional), 5/6/2016 - 5/6/2018

Source: Bloomberg, May 15, 2018 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.

This money on the move matters to more than the prime money market business. The corporations issuing that commercial paper may be reducing their own short-term borrowing – a mainstay of funding share buybacks, mergers and strong dividend flows. Due to the reduction of issuance, a possible outcome could be a reduction of the amount of available commercial paper. If demand were to stay stable, that shortage could exert downward pressure on yields – one of the few places to find such pressure at the moment.

 

On the Slide: Argentina’s peso – up to a point

On Monday, Argentina’s central bank, the BCRA, took a major stand to defend its deteriorating currency – and they won the skirmish in the markets the following day. The bank committed $5 billion to the market at 25 pesos per U.S. dollar – nearly 10% of the country’s foreign exchange reserves. On Tuesday, the peso held to that price, and actually rose to 23.77 before falling back slightly to 24.055.

There were two components to Tuesday’s success. First, a pledge to the country’s banks to hold firm on the peso, which helped garner some market support from the private sector. Second, Argentina’s currency is “low-volume”; the Bank for International Settlements (BIS) estimated that the peso trades roughly $2 billion a day. Even the Chilean peso trades more -- $12 billion a day. Reports are that $1.1 billion of the $5 billion commitment was traded on Tuesday, leaving plenty of ammunition available to defend the currency on Wednesday. 


Argentina Peso Per U.S. Dollar, 4/25/18 - 5/15/18

Source: Bloomberg, May 15, 2018 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.


Does that erase the overall advantage of owning local-currency EM bonds? Most likely, that depends on the specific bond and country. In any event, this change could be thought of as one of several side-effects of the flow of funds to the U.S. short end from elsewhere.

 


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