Missiles, floods, lift bonds

Mid-Week Bond Update

Missiles, floods, lift bonds

Natural and not-so natural disasters, including storms and a North Korean missile flying over Japan, lifted demand for government bonds, especially those with the longest maturities. UK inflation-linked debt and US Treasuries maturing in more than 25 years outperformed...

over the past five trading days, as their long-term profile could benefit more from a falling yield environment. Although the five-day period ended on a high, following an upwards revision of US economic growth data, the week had been marked by rising geopolitical tensions between North Korea and the US and by the aftermath of the storm in Texas, which has left thousands homeless and could hinder economic growth. The US dollar fell to its lowest level since May last year.

The drop coincided with rising momentum in Europe, where economic confidence reached a decade-high and the currency continued to rally against the US dollar. Markets slightly interpreted the lack of headlines from the recent central banks’ gathering in Jackson Hole as a dovish sign, pushing market-implied probabilities of a US December rate hike down to 37%, from 42% just before the meeting. Expectations of a September hike continue at a low 12%, given the still mixed economic data. Oil plunged to $US 46 per barrel as the floods in Texas hit Houston’s port, one of the main gates to and from the US oil and gas industry. Currencies of oil-exporting countries, such as the Russian ruble and the Colombian peso, dropped. Click here to read the latest world view from Western Asset’s Chief Investment Officer Ken Leech.

 

ON THE RISE

Germany – shopping-fest? German inflation accelerated to an annualised 1.8% in August, above expectations and a sign of Europe’s rising momentum: Eurozone August economic confidence reached a decade-high also in August, partially driven by Germany, the region’s leader. As shown on the chart, a pick-up in German prices is often mirrored by a rising euro, whose rally against the US dollar since December has been practically non-stop. While German manufacturers have enjoyed years of a low euro, the country’s growth and inflation are now being revived by Consumption, which grew in the second quarter by 0.8%, the fastest pace since 2011. This is good news for the many critics of Germany’s traditional savings culture – as the country’s present 7.9% Current Account surplus, one of the world’s largest, implies deficits elsewhere. Time for a shopping-fest?

 

What is good for Germany is good for Europe

Source: Bloomberg 30 August 2017. CPI is Consumer Price Index; USD is US dollar; RHS is right hand side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

Chile and copper – on wheels: The Chilean peso rallied 1.5% against the US dollar over the past five trading days, more than any other Emerging Markets (EM) currency, as the country’s industrial production jumped by most in more than two years in July. The rebound is mostly led by soaring copper prices, which reached a three-year high this month – as the metal accounts for about half of Chilean exports. Copper is increasingly demanded by the rising electric-car industry, by more infrastructure projects in developing nations and by China, which has been able to keep economic growth at just under the 7% level. According to the Bank of International Settlements’ Real Effective Exchange Rate mechanism, the Chilean peso is 7.2% undervalued.

 

ON THE SLIDE

US yield curve – defying gravity: US long-maturity Treasury bonds continued to defy traditional fixed income gravity laws over the past five trading days. Despite unemployment being at record lows and upward revisions to Gross Domestic Product readings, Treasuries with the longest maturities continue to outperform those with shorter life-spans, which traditionally move more in synch with the Federal Funds rate. Longer maturity bonds, on the contrary, tend to reflect more long-term trends in growth and inflation, which at the moment continue to look bleak. As shown on the chart, the US yield curve has flattened again so far this year, an indication that investors aren’t expecting a substantial economic boom at any time soon. This protracted backdrop of low inflation and low yields may favour equity-like bond asset classes, such as High Yield. Click here to read Brandywine Global’s views on the US and International High Yield markets.

 

Long is beautiful: US yield curve flattens again

Difference (in basis points):

 

Source: Bloomberg as of 30 August 2017. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

Yen and Japanese yields – finally down: The yen weakened against the US dollar over the past five trading days, as the country’s central bank governor Haruhiko Kuroda appeared as the most dovish central banker at the recent bankers’ gathering in Jackson Hole, Wyoming. While the US Federal Reserve and the European Central Bank are already or are expected to be on a hiking path soon, Kuroda continues to reassure markets that the country’s monetary stimulus has no end in sight. His comments helped drop Japan’s 10 year-sovereign bond yield under 0% for the first time since April – a threshold that the bank has established in order to stimulate growth. The task is not easy, though, as global safe-haven flights tend to lift demand for Japan’s currency and bonds. The central bank’s tenacity, though, seems unquestionable: the efforts to revive the economy are now two-decades old.

 

Source for all data: Bloomberg and Barclays Capital as of 30 August 2017, unless indicated.

 

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