From Berlin to Pyongyang, via Istanbul, Tokyo and Barcelona, political uncertainty came back to dominate global bond markets, pushing up demand for both traditional safe-havens and growth-sensitive asset classes. US Non-Agency Mortgage-Backed Securities and corporate bonds gained on...
the back of US president Trump’s expected tax cuts, and also following some comments from Federal Reserve (Fed) chair Janet Yellen, which the market perceived as hawkish. On the other hand, the Fed’s cutting of its own inflation projections lifted demand for US long-maturity Treasuries, which normally don’t move in total sync with corporate bond markets.
But it was an odd week: starting in Berlin on Sunday night, the euro took a setback from its recent rally since April after German Chancellor Angela Merkel won a fourth mandate, but with less support than expected, forcing her to form a coalition government. The yen took a similar battering after president Abe called a snap election aimed at reassuring his stimulus plan. At the same time, an escalation of tensions between the US and North Korea lifted demand for developed market government bonds, also sought after following a pro-independence referendum in Iraq’s Kurdish region. Turkish threats to halt a Kurdish oil pipeline amid the independence vote unsettled markets and sent the commodity above US$50 per barrel, the highest since April. Another pro-independence referendum planned for this Sunday in Spain’s north-eastern region of Catalonia also added to the uncertainty as Spain’s government has declared the vote illegal. The overall increased uncertainty lifted the US dollar higher, hitting Emerging Markets.
ON THE RISE
Political risk – referendum fatigue: After a plethora of national elections in Europe in the first half of the year, few believed that the political scene could intensify in the second half. But Angela Merkel’s close victory in Germany on Sunday opened a full-on week that has derailed the euro and the yen and lifted oil prices and the US dollar, all over the past three days. Regarding Germany, investors are concerned that a weaker Merkel government may affect her strong leadership of the European Union, which is also facing tensions in Spain with this weekend’s planned independence vote in Catalonia: while the Spanish government says the move is illegal, Catalan leaders insist the vote will go ahead. The uncertainty has lifted the cost to protect investors against a potential sovereign default over the past week, as seen on the chart. Default protection costs, measured by Credit Default Swaps, also rose in Japan, where president Abe called a snap election to guarantee the continuation of his multi-billion yen stimulus programme. The yen dropped.
Politics matters: Planned votes in Spain, Japan weaken currencies, debt profiles
Source: Bloomberg Barclays 27 September 2017. USD is US dollar. CDS is Credit Default Swap and RHS is Right Hand Side. Past performance is no guarantee of future results. Please see disclaimers for definitions.
Indonesia – surprise rate cut: Indonesian sovereign bonds extended gains over the past five trading days, taking their year-to-date return to 14%, the best performance among Asian sovereigns. The recent move was triggered by an unexpected 25 basis points rate cut, to 4.25%, last Friday. The country has kept its annualised economic growth at around 5% for almost four years, while annual inflation growth has mostly stayed below 4% since January 2016. This relative stability and local nominal yields of about 6.4%, for the 10-year sovereign bond, have helped attract yield-hungry global investors. Foreign investors now own more than 40% of the country’s sovereign debt.
ON THE SLIDE
Markets – Fed: DOTS apart: The Fed and financial markets continued to diverge this week, despite the central bank’s repeated efforts to explain that rates do really need to go up. The Fed’s so called “dot-plot” (where rate-setting committee members put their projections on a chart) showed that the central bank continues to see one more rate hike this year and three more in 2018. Markets, however, only see one rate hike next year, after one in December. The difference mostly stems from the fact that US inflation, at an annualised 1.4%, is still well below the central bank’s 2% target, something that has kept inflation expectations at bay over the past few months. This ambivalence has also flattened the difference between US Treasury 30-year and 10-year yields to barely 54 basis points, near levels not seen since the 2008-09 financial crisis. Click here to read Brandywine Global’s views of the Fed moves and what risks and opportunities could lay ahead.
The Fed and the markets: different rate perspectives
Source: Bloomberg as of 27 September 2017. OIS is Overnight Index Swap; Fed is Federal Reserve. Past performance is no guarantee of future results. Please find definitions in the disclaimer.
EMs – dollar hit: Most Emerging Markets (EMs) suffered over the past five trading days from a rising dollar - which makes their foreign debt more expensive. Some countries, however, also lost investors’ favour on their own merit: the Indian rupee, for instance, dropped 1.4% against the greenback after the government said it was considering expanding its spending, while the South African rand lost ground after the central bank left rates unchanged – when investors were expecting a cut. The Russian ruble, however, added 0.7% on the back of rising oil prices. Oil-exporting Russia has increased its annual economic growth to 2.5%, the highest since 2013, while inflation has dropped to 3.3%, the lowest since at least 1992.
Source for all data: Bloomberg and Barclays Capital as of 27 Sept. 2017, unless indicated.