US Treasury Inflation Protected Securities (TIPS) and inflation expectations sank over the past five trading days amid renewed White House turbulence, this time involving an alleged manipulation of security leaks. The turmoil took steam off the already waning...
“Trump trade,” as investors expect the US president to be more focused on his own defence than on reflating the economy. The US dollar sank to the level it had in November, completely erasing its post-election rally. Lower growth expectations drove demand for US Treasuries, pushing the world benchmark 10 year yield down to 2.24%, a sharp drop from the 2.41% it was trading at only last week. Inflation expectations also receded to election-day levels, with the difference between the 10 year nominal and inflation-adjusted yield dropping to 1.82%, after surpassing 2% in January.
Emerging Markets (EMs) shone against a falling greenback, as a challenged president could tone down his protectionist rhetoric, or his plans to build up a wall on the Mexican border. The Mexican peso soared 2.28% against its neighbour currency to 18.3 units per dollar, exactly where it was on November 8. EM currencies of oil-exporting countries were further boosted by soaring oil prices, following Russia and Saudi Arabia’s commitment to more output cuts. The Colombian peso and the Brazilian real strengthened 2.8% and 2.6% against the greenback, respectively. Eurozone sovereign and corporate bonds lagged behind the global bond rally on the back of continuously improving data: this time, Germany’s ZEW index of business confidence rose to 83.9 in May, above consensus and the highest level since July 2011. The traditionally safe German and French sovereign bonds have also dropped since Emmanuel Macron won the French election on May 7, beating an anti-euro rival and therefore offering more stability to the European project. Even the British pound rose against the dollar, despite dismal economic data.
ON THE RISE
Long bonds – long friendship: Like a resurging old friendship, long-maturity US Treasuries came out from the void and soared almost 1% over the past five trading days, challenging the widespread belief that the ongoing reflationary forces would weigh on bonds. Despite market hopes that US economic growth is back on track, economic data once again told a different story: Both consumer prices and retail sales came in below expectations in April, the second monthly disappointment in a row. While US 30-year yields have dropped over the past ten years, economic growth and inflation have fallen even more, making some investors, such as Western Asset, believe that they could still offer some value. US inflation expectations have also fallen, not only because of the cooling down of the “Trump trade,” but also because of deeper structural issues, such as low productivity and technology developments. An ageing population in Europe and Japan, which face lower or even negative bond yields, also underpins demand for long-maturity Treasuries.
The battle of the drops
Long Treasury yields have fallen, but inflation has dropped more
Source: Bloomberg as of 17 May 2017. UST is US Treasury; PCE is Personal Consumption Expenditure; GDP is Gross Domestic Product; yr is year; RHS is right hand side. Please find definitions in the disclaimer.
Emerging Markets – Trumpfest: EM local sovereign bonds were the best-performing asset class over the past five trading days, boosted by a sinking US dollar and surging commodity prices – for them, a dream scenario. Gains were led by oil-price sensitive nations, such as Brazil and Russia, as well as by Eastern European countries, which could benefit from a pick-up in Eurozone growth. Fundamentals are also driving the EM story. Indian bonds, for instance, added 0.6% over the past five trading days after consumer prices rose 2.99% in April, below estimates of 3.3%. The rupee has gained 5.9% against the dollar so far this year, boosted by an anticipated better growth outlook, president Modi’s gains in state elections, and the flow of capital from both foreign direct and portfolio investments. Click here to read Brandywine Global’s views on global Fixed Income markets.
ON THE SLIDE
China yield curve – inverted signals? China’s sovereign bond yield curve, which shows the yield for each maturity, has recently inverted at the 7-10 year level, something which normally signals a bleak future. Generally, a lower premium for longer-term than shorter-term bonds often means that investors don’t have much faith in future growth or inflation. But given the reduced international presence in China’s bond market, and the upsloping curve after the 10 year level, some observers have said that they 10-year yield drop is a knee-jerk reaction to new government measures to rein in booming credit growth and a growing shadow banking industry. The country has reassured its commitment to expansive fiscal and monetary policies in order to stem a decline in economic growth. This has been sustained at or above a 6.7% annualised level for more than one year, rising to 6.9% in the first quarter.
Yield curve blip or short-term cure? China’s yield curve inverts
|Source: Bloomberg as of 17 May 2017. Past performance is no guarantee of future results. Please find definitions in the disclaimer.|
Britain – rainy: Britons are having a dismal May and not only for the rain pouring all over the country: Industrial Production fell in March for a third consecutive month and real wages dropped 0.2%, also in the same month. After inflation shot up to an annualised 2.7% in April, the real value of the money taken home could be further squeezed in the future. Brits are also poorer abroad, as the pound has dropped 13% since the country decided last year to leave the European Union. This backdrop has intensified the debate ahead the forthcoming general election on June 8. The phlegm is up.
Source for all data: Bloomberg and Barclays Capital as of 17 May 2017, unless indicated.