Watchful Waiting

Mid-Week Bond Update

Watchful Waiting

For the most part, bond markets spent the past week holding their collective breath, as pronouncements and decisions from the European Central Bank (ECB) and the Federal Reserve (Fed) unfolded.

U.S. 5-year Treasury yields moved up about 5 basis points (bps) to 1.878%, while yields mostly fell for European sovereigns, from Portugal’s -9.0 bps decline to 1.156% to Sweden’s relatively mild -2.0 bps fall to -0.091%. UK 5-year sovereign yields bucked the trend, rising 0.5 bps to 0.582%. The biggest major gainer was Canada, whose 1.613% yield on its 5-year was 9.4 bps higher than a week ago, on an economic forecast upgrade from the International Monetary Fund (IMF). Mexico saw a 5.6 bps rise as well.  Mexico was also the biggest gainer among emerging market (EM) US-dollar-denominated (USD) bonds, up 6.6 bps to 3.032%. Most other EM USD didn’t follow suit, with Argentina seeing a -7.0 bps fall to 4.455%. In local-currency EM, Pakistan, Turkey and Colombia rose 17.0, 16.7 and 8.3 bps respectively, while South Korea and Lithuania yields fell -1.3 and -1.5 bps respectively.  The local-currency outlier to the downside was South Africa, with a -19.0 bps fall, to a rand-denominated 7.421% yield. U.S. break-even inflation rates came in at 1.68% (5-year) and 1.801% (10-year), suggesting that the Fed has more work to do to convince the U.S. bond market that it can achieve its steady-state 2% target for inflation.

 

ON THE RISE

U.S. 10-year Treasuries – Get a grip   Much was made of the jump in 10-year Treasury yields during trading on 25 July – a peak-to-trough rise of 8.9 basis points (bps), from 2.246% to 2.335%. With observers examining each twitch of the bond markets for signs of sudden changes in inflation expectations, the move was described by some as harbinger of some sort of surprise from the Federal Reserve (Fed), whose regularly-scheduled meeting of the Federal Open Market Committee (FOMC) is otherwise widely expected to generate no news. Other explanations credit a sudden renewed bullishness about the prospects for economic growth, citing strong earnings releases.  But more seasoned observers noted that the move kept the 10-year yield well within the 2.15%-to-2.6% trading range in the wake of November 2016’s election of Donald Trump. 

10-year US Treasuries: Keeping it in perspective

Yield on generic 10-year U.S. Treasuries, 25 July 2016 to 25 July 2017

Source: Bloomberg as of 26 June 2017. Please find definitions in the disclaimer. 

 

South Korea – Help wanted South Korea’s National Assembly approved a $10 billion supplemental budget on Saturday aimed at creating public-sector jobs to put some of the country’s 1 million unemployed—half of which are between the ages of 15 and 29—back to work. On Tuesday, the finance ministry raised its outlook for economic growth to 3% for 2017, which would be the fastest since 3.3% in 2014 and is higher than the Bank of Korea forecast of 2.8%. The news was well received by the bond market as the 10-year sovereign bond yield fell by 6pbs to the lowest level this month; the spread to the benchmark 10 year U.S. Treasury tightened by 12 bps.  At 2.19% on 7/25/17, the 10-year yield was down from a July high of 2.30% on 7/7/17, but still above the recent low of 2.11% reached on 6/27/17.

 

ON THE SLIDE

Retail - No more shop ‘til you drop Over the past week, high yield retailers outperformed the sector in general as yields in that sector dropped by 17 basis points compared to just 10 bps for the overall high yield index. However, that’s not the real story. As the chart below shows, yields in the high yield retail sector have diverged from the sector in general in recent months. This reflects the challenges facing traditional retailers including Millennials who seem to prefer services and experiences over stuff, but more importantly there are secular changes such as the evolution and adoption of new technologies that continue to drive the growth of online shopping, which offers shoppers liberation from the checkout lane.

 

The retail shuffle is secular, not cyclical

Bloomberg Barclays U.S. Corporate High Yield Index and HY Retail Sector

Source: Bloomberg as of 24 July 2017. Please find definitions in the disclaimer. 

 

U.S. dollar: Victim or victor?  The U.S. dollar has fallen some 8% so far this year against a trade-weighted basket of currencies, and is down just under -10% against the euro. U.S. pundits have been quick to blame recent disorder in Washington, but there are more fundamental reasons for the descent.  Most prominent: a change in interest rate expectations on the short end of the yield curve – largely the result of Fed actions and comments. After three 25 basis point (bps) hikes since the beginning of December, Chair Yellen and her colleagues have shaded their optimism about the economy in light of stubbornly low inflation – leading some to wonder if another hike this year could be on hold.  Currency traders may already have incorporated this doubt; after all, inflation has been below the Fed’s 2% target level for quite some time. Add to that recent strength in the European economy and ECB President Draghi’s gentle but clear hints that a rate rise could be in the offing – factors which may be driving the euro higher against the dollar in particular.

 


Source for all data: Bloomberg, as of 26 July 2017, unless indicated.

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