Back From the Brink: A Cautionary Tale?

Mid Week Bond Update

Back From the Brink: A Cautionary Tale?

The agreement announced June 22 between Greece and the rest of the European Union deferred repayment of older bailout loans by ten years...


...and extended their maturities by the same amount of time, reducing the size of its debt repayments substantially until after 2030. The deal also increased the size of the final tranche of bailout money to €15 billion, an agreement won with difficulty from Germany, which has been reluctant to make this concession since the beginning of the crisis in 2011.

Words of praise came from ECB President Mario Draghi and IMF managing director Christine Lagarde, along with the expected expressions of relief from Greek ministers, suggesting that acceptance of the agreement by the IMF would be forthcoming. Financial markets responded positively, with the yield of the Greek 5-year benchmark bond reaching 3.33% – a far cry from the 65.9% yield reached in March 2012 at the peak of the crisis.

All this should put current anxieties about Italy’s smoldering economic and political difficulties into perspective. While Italy’s bonds reacted sharply to the current government’s platform, that reaction was dwarfed by Greece’s bond gyrations over the course of the past few years.  That’s not to say that Italy’s troubles are insignificant; as the fourth-largest economy in the Eurozone, a little trouble could go a long way in terms of impact on the region as a whole.




Source: Bloomberg, June 26, 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: Liquidity in China’s banking system

The announcement by the People’s Bank of China of a 50 basis point reduction in the Reserve Requirement Rate (RRR) to 15.50%, starting July 5, is expected to release some $107 billion into the financial system to support “debt-for-equity swaps and financing of small and micro-sized businesses.”1 The swaps and support for small businesses are associated with the challenges in China’s bond market. The PBOC clarified the policy by saying that the move was not a loosening of general monetary policy, but rather a way to finance the country’s “economic restructuring,” a reference to the ongoing reform of the financial system.  To underscore the seriousness of the initiative, the PBoC will require that “the relevant banks record each such swap in detail and report it, to both the PBoC and to related departments” on a quarterly basis.

Adjustment of the RRR is somewhat unusual; it was reduced by 1.0% to 16.00% on April 25, 2017; the previous reduction, of 0.5% to 17.00%, took place March 1, 2016.

On the Slide: U.S. 10 Year Treasury Yield

The yield of the 10-year Treasury briefly reached as high as 3.001% at 2:30 PM ET on June 13, at the beginning of Fed Chairman Powell’s press conference following the FOMC’s announcement of a 25 basis points rise in the target rate to 2.00%. Ten trading days later, at 9:30 PM ET on June 26, the yield had fallen to 2.878%, some 12 basis points lower, ending for the moment worries about the 3% level being breached on the upside.

Attention has instead shifted to the shorter end, where the need to finance growth in government spending has resulted in plentiful supply from the Treasury Department, pushing yields upward in the 1-month to 3-year range.

Meanwhile, the long end of the bond market appears to be driven by skepticism about growth-fueled inflation in the coming years; the 30-year Treasury has risen just over 28 basis points since the beginning of the year, dwarfed by the 3-year’s 65.4 basis point rise. Whether these shifts in the U.S. yield curve portend an impending recession will only be known in retrospect.

 


1 Source: China Daily, June 27 2018

All market data Source: Bloomberg, as of specified dates.

 

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