Quiet week…too quiet?

Mid-Week Bond Update

Quiet week…too quiet?

Most bond sectors saw modest gains over the past week with underperformance in inflation-linked sectors being a notable exception, consistent with signs...

...of softer inflation data in many countries. Benchmark government bonds gained ground as yields drifted lower over the past week. 10-year UST yields were down to 2.21% on 5/30/17 from 2.25% on 5/24/17; 10-year German bund yields declined to 0.288% from 0.399%; and JGBs slid 15 basis points (bps) to 0.27% over the same period. The global high yield sector gained as well with the yield to worst of the Bloomberg Barclays Global High Yield Bond Index declining from 5.22% to 5.18%, its lowest level since May 2014; the index spread was little changed. Modest gains were also seen in emerging market sectors. Meanwhile, investment-grade corporate yields in Europe were little changed and down modestly in the U.S. The U.S. dollar was basically stable over the past five days; the top 3 currencies advancing versus the dollar were the Israeli shekel, New Zealand dollar and Brazilian real, while the top 3 declining currencies were South African rand, Mexican peso and Norwegian krone. Generally speaking, commodity prices weakened modestly with the price of oil declining despite the agreement between OPEC and other oil producers to extend production cuts. Several inflation readings were soft during the week including May consumer prices in the Eurozone and the Core PCE reading for April in the U.S. The prices components of China’s PMIs for May were also soft, suggesting that producer prices for May could be down relative to April. The 10-year sovereign yield curve in China between 2 and 10 years was flat over the past week. Despite lower inflation data in the U.S., the Federal Reserve is still expected to increase rates at its mid-June meeting.



U.S. Treasuries—renewed interest abroad  Some world central banks are showing renewed interest in purchasing U.S. Treasuries now that the U.S. dollar has weakened against many world currencies this year. The DXY dollar index was down -4.98% for the year through May 31st. With the U.S. dollar weaker, many central banks are under less pressure to support the value of their currencies, which they tend to do by selling U.S. Treasuries held in reserve accounts. Yet not only have they stopped selling Treasuries, but they’re buying again. The Federal Reserve reported that U.S. debt holdings held by foreign central banks were $2.92 trillion in late May, which is the highest level in almost a year. Such renewed interest could keep downward pressure on U.S. bond yields, which still offer higher yields than their developed market peers. As of May 30th, 10-year U.S. Treasury bonds yielded 2.21% compared with 0.288% for German bunds, 1.013% for UK Gilts and 0.027% for Japanese Government Bonds.


US Treasuries: Back in demand

Marketable USTs held in custody for foreign official and international accounts                                  

Source: Bloomberg as of 31 May 2017. Please find definitions in the disclaimer. 


Thailand - a baht time for recovery Thailand’s currency, the baht, was the top performing EM currency over our reporting week, gaining 0.75% versus the U.S. dollar. The currency received a likely boost from news last week that the Thai economy grew 3.3% in the first quarter, raising hopes that the country's sluggish recovery would begin to pick up speed.  The economy experienced a steep recession in 2014 as well as a military coup against the government of Yingluck Shinawatra. The recovery that began last year has been gradual, despite a central bank rate that’s been set at 1.5% for almost two years; Thailand’s growth has significantly lagged its regional peers. The military-led government is attempting to ensure political stability and promote growth with infrastructure spending and other initiatives, hoping to restore confidence in the country as a destination for foreign investment. The efforts might be bearing fruit: a leading American motorcycle manufacturer announced last week that it would build a plant in Thailand to serve the growing regional market and major European and U.S. aircraft companies are interested in the government’s plans to revitalize a Vietnam War era airport to challenge Singapore as a hub for aircraft maintenance, repair and overhaul—both signs that outside confidence might be on the rise. However, political distrust reportedly still simmers under the surface of the current calm so time will tell if a new constitution that clears the way for new elections in 2018 will succeed in bringing about lasting change and revitalized growth.



Consumer prices–Not taking off  Inflation in the Eurozone was weaker than expected in May and the U.S. Federal Reserve’s (Fed) preferred measure of inflation—the core personal consumption expenditure (PCE) deflator—fell back in April to the lowest level since December 2015. Consumer prices in the Eurozone were up 1.77% in May from a year ago, a slower pace from the 1.9% gain registered in April and further below the ECB’s target of 2%. However, the slide relative to April was less for the whole region than for Germany where it was just 1.4% in May compared with 2% the previous month. In the U.S. core PCE was 1.54% in April, down slightly from 1.79% in January 2017 and the lowest since 1.39% in December 2015. The headline PCE also slipped in April to 1.7% from 1.9% in March and 2.1% in February—the latter marking the first time in five years that PCE inflation has exceeded the Fed’s 2% target. Officials still believe the longer trend is toward higher inflation, but nothing dramatic—and that certainly removes pressure from both the ECB and the Fed to move any way other than slow with respect to policy normalization, which should allow the markets to adjust gradually as well.


Eurozone inflation slowed in May

Euro area consumer prices, year over year (%)

Source: Bloomberg as of 31 May 2017. Please find definitions in the disclaimer. 


Venezuela: respite, not rescue The latest evidence of the government's growing desperation:  the government treasury's sale of $2.8 bn of  bonds (face-value) of PDVSA to raise desperately-needed cash. The discount was reportedly 32 cents on the dollar; that's a steep discount. But the political price was high for the buyer, Goldman Sachs. Venezuela's opposition-led Congress accused the bank of both taking advantage of a desperate situation and at the same time supporting – however briefly – the current regime's continued rule. With some estimating that up to 70% of Venezuela's population is unable to afford three meals a day, the $890 million cash raised by the sale of so-called "hunger bonds" is far from adequate to get Venezuelans fed and the country's oil infrastructure back into shape after years of underinvestment by the government-owned oil company.  


Source for all data: Bloomberg, as of 31 May 2017, unless indicated.


IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Outperformance does not imply positive results.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

U.S. Treasury Inflation Protected Securities (“TIPS”) are bonds that receive a fixed, stated rate of return, but they also increase their principal by the changes in the CPI-U (the non-seasonally adjusted U.S. city average of the all-item consumer price index for all urban consumers, published by the Bureau of Labor Statistics). TIPS, like most fixed income instruments with long maturities, are subject to price risk.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.