Is the Fed ignoring Cassandra signs?

Mid-Week Bond Update

Is the Fed ignoring Cassandra signs?

Most fixed income sectors had a torrid past five trading days, as inflation picked up in the US – which, as expected, lifted interest rates by 25 basis points to 1.5%. However, not everyone seemed convinced about the US Federal Reserve’s (Fed) growth outlook, mostly because of still below-target inflation. At 1.44%, the core...

Personal Consumption Expenditure Index is well below the central bank’s 2% target – a level it last reached in 2012. The inflation concerns continued to drive the flattening of the US yield curve, with the difference between 10 and 30-year Treasury yields falling to 37.5 basis points (bps), the lowest since 2008 – hardly a sign of optimism. Some investors, such as Western Asset, have warned that the yield curve is giving messages that should not be ignored – click here to read Western Asset Chief Investment Officer Ken Leech’s comparison of the US yield curve to Cassandra, the Greek mythology figure whose predictions were always right, yet never believed.

Despite the yield curve signals, the US dollar extended its December upwards march, rising against most developed market currencies except the New Zealand dollar. The kiwi gained after Adrian Orr, the country’s sovereign wealth fund chief executive, was appointed new central bank governor – and is seen as less of a dove. Emerging Markets (EM) suffered from the dollar’s rise, especially the Brazilian real and the Mexican peso: the real plunged 2.5% against the greenback on concerns about the country’s planned pension reform, while the peso fell 1.7% after a diplomat said the North American Free Trade Agreement (NAFTA) had 50-50% chances of survival. US High Yield and leveraged bank loans were amongst the few fixed income sectors to post modest gains, lifted by expectations that president Trump’s proposed tax cuts may accelerate economic growth.



Yellen – leaving on a hike: Janet Yellen hosted her last press conference as Fed chair on Wednesday, after lifting interest rates for a fifth time since taking over the role in 2014 – not bad for somebody who landed the job with a big dove reputation. Yellen will leave US interest rates higher than she found them, unlike her three predecessors: Volker left them lower, despite lifting them to as high as 20% to contain inflation soon after being appointed in 1979, while Greenspan also cut them in a move much criticised for helping create the conditions that ultimately led to the 2007-08 financial crisis. Bernanke cut them sharply in order to get the US out of recession. Yellen also differs from her precursors in terms of unemployment, which has fallen more during her tenure than it did during the Volker, Greenspan and Bernanke years. Her battle, however, has been against inflation, which has remained stubbornly low, something which she called a mystery. Over her almost four years in charge, inflation has barely moved, despite her efforts to reignite the economy. The first woman to ever chair the Fed plans to leave the central bank and will be replaced by Jerome Powell, whose views and gradual approach are seen as similar to hers. Click here to read more about Yellen's last hike.


Yellen’s legacy: unemployment win, inflation struggle


Source: Bloomberg Barclays Capital 13 Dec. 2017. Please see disclaimers for definitions.


Japan – lip (export) service? After two decades fighting to get out of stagnation, Japan finally surprised with above-forecast growth: the country’s Gross Domestic Product (GDP) was revised up to an annualised 2.5% in the third quarter, from an initial estimate of 1.4%. The change was mainly due to an upgrade of non-residential and inventory investment estimates – all signs of faith in the economy. As a result, the yen slightly strengthened against the US dollar – a rise that was quickly contained as soon as officials reassured commitment to their monetary stimulus. A low yen has helped boost Japan’s exports – and the country’s overall economic growth.



Brits at work – Brussels routs: While British and European Union (EU) diplomats celebrated an initial deal reached over Britain’s departure from the trading bloc, Britons faced tougher conditions at home: away from the glowing Brussels headlines, the number of people at work in the UK fell by 56,000 between August and October, the fastest pace in almost two and a half years. Apart from the departure of EU nationals back to their countries after Britain’s decision to leave the EU, Britons may also be discouraged by inflation outpacing wage growth: prices rose at an annualised 3.1% in November, above estimates and the highest since 2012. The pound fell less than the yen and the euro against a rising US dollar over the past five trading days, as investors expect further rate hikes in the UK next year – something which may lead to more routs than (economic) sprouts in the future.


More routs than sprouts: Fewer Britons at work as wage growth lags inflation

Source: Bloomberg as of 13 Dec. 2017. RHS is Right hand side. Please find definitions in the disclaimer.


Brazil – pension angst: Local sovereign bond yields rose, the currency plunged against the US dollar and political action intensified as president Temer battled to keep his planned pension reform alive. The belief that such overhaul would help the country improve its ailing coffers has attracted international investors throughout the year, lifting demand for Brazil’s local debt – taking its year-to-date return to 13.5%, in dollar terms. The plan, however, has been recently challenged amid low support, leading to a delay in the vote. Hopes, however, are high again after the Social Democratic Party, Brazil’s third-largest party, gave support to the proposal. The most optimists believe a December vote is still possible.


Source for all data: Bloomberg and Barclays Capital as of 13 Dec. 2017, unless indicated.


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