Risk wins lost decade

Mid-Week Bond Update

Risk wins lost decade

The poor week that traditional fixed income risk assets are having doesn’t resemble their story for the past ten years: In the month that marks the tenth anniversary of the outbreak of the global financial crisis, sectors such as...

High Yield, non-agency mortgage-backed securities and Emerging Market bonds have locked up in some cases triple digit gains, well ahead of equity returns over the same period. While some market observers argue that these returns have been artificially supported by central bank stimulus programmes and yield-hungry investors, others think that the assets are sustained by improved fundamentals, such as lower inflation and deficits in Emerging Markets (EMs) and financially healthier companies in leading economies. Which view is right may be clear soon, as some central banks, such as the US Federal Reserve (Fed) are already exiting a decade of monetary support. In the case of EMs, some investors, such as Western Asset, believe that the asset class is now more resilient and should not significantly suffer from a tighter Fed policy. Click here to read John Bellow’s “Four lessons from the Taper Tantrum.”

But, as for the week, risk assets and global fixed income bonds in general were challenged by improved US economic data, including July retail sales, and lesser geopolitical tension between the US and North Korea, which had triggered a safe-haven rush last week. Oil and the US dollar reversed a declining trend, hitting EMs, especially those with US dollar-denominated debt. Currencies of oil-exporting countries, such as Russia, Mexico and Colombia, rose. EM sentiment also faded following weak Chinese data, including July trade figures and Industrial Output, both of which below expectations. The upswing surprise came from Japan, which posted annualised second-quarter Gross Domestic Product growth of 4%, almost twice the estimates.



Risk run – the story of the decade: As investors look back to the start of the crisis exactly ten years ago this month, some may wish they could have then looked forward. Traditionally riskier fixed income asset classes have posted stellar gains over the past decade, especially as some, such as non-agency mortgage-backed bonds or High Yield debt, started at particularly low prices given the sell-off that took place at the time. High Yield spreads, for instance, shot up to almost 2,000 basis points (bps), a scenario that implied that very few companies would survive the period. US High Yield spreads trade now at 378 basis points, having averaged 506 bps since 2010 – proving that the Armageddon scenario the 2008 spreads implied never happened. As always, it tends to be the active and independently-minded investors who spot such opportunities that do best. For a contrarian view today, read Brandywine Global’s “Around the Curve” blog: The reports of UK economic demise appear to have been greatly exaggerated.


A golden decade for Fixed Income risk assets (% Return: August 2007-August 2017)

Fixed Income Risk Assets

Source: Bloomberg 16 August 2017. HY is High Yield, Agen. Is Agency, GBP is British pound, MBS are mortgage-backed securities, USD is US dollar, gov is government, yr is year, corp is corporate. Past performance is no guarantee of future results. Please find definitions in the disclaimer.


Argentina – Let’s change! Argentina’s currency and sovereign bonds rallied over the past five trading days, boosted by the outcome of a national primary election, in which president Macri’s party candidates did better than expected. The incumbent Cambiemos’ (Let’s change) positive result is especially relevant ahead of the country’s congressional elections in October. Even in the Buenos Aires province, with a strong Peronist support, former president Cristina Fernandez de Kirchner unexpectedly tied with Macri’s candidate, when she was expected to win. Markets, generally supportive of Macri’s reforms plans, cheered the result: the peso surged 3.5% against the US dollar over the past five trading days, while Argentinean local sovereign bond spreads tightened by 64 bps to 13.8%.



China’s money supply – reining in credit, but also growth? China’s money supply, or the amount of money in circulation, fell in July to the lowest level in almost 30 years – a sign of the government’s commitment to rein in booming credit, protect its financial system and stem capital outflows. But since Money supply is often seen as a factor that can affect business cycles, the trend has raised concerns about an economic slowdown. However, and as seen on the chart, while money supply and economic growth generally follow a similar trend, growth has stayed at a level just under 7% over the past 2 years, while money supply growth has dropped from 14% to the current 9.2%. This week, the International Monetary Fund (IMF) raised its average annual growth estimate for the country through 2020 to 6.4%, up from a previous 6%. However, the IMF warned that this growth would be fuelled by rising debt. Some investors believe money supply may still have further to fall – it is still well above the US’s equivalent rate of 5.6%. Could a further drop challenge growth? Click here to read Martin Currie’s Kim Catechis note: “China: clearer skies ahead.”


Balancing act: keeping up growth with less money supply

China GDP Growth

Source: Bloomberg as of 16 August 2017. GDP is Gross Domestic Product. Past performance is no guarantee of future results. Please find definitions in the disclaimer.


UK – inflation holds: British consumers were finally given some good news: annualised inflation held at 2.6% in July, below estimates, raising hopes that the Bank of England will refrain from raising interest rates any time soon. Challenged by Brexit negotiations, a weaker currency and unconvincing economic data, prime minister Theresa May’s government unveiled this week a plan to orderly leave the European Union – which raised more questions than answers. The pound weakened 1% against the US dollar.


Source for all data: Bloomberg and Barclays Capital as of 16 August 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.

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