Tariff Tantrum

Mid Week Bond Update

Tariff Tantrum

The brief outburst of trade threats at the end of last week may have been cover for a relatively focused series of bilateral negotiations between the U.S. and a select list of trade partners...


...during which there will be ample opportunity for economic, industrial and political influences to be felt before decisions are made. That could be why markets were mollified – at least on Monday March 26 – getting back to the business of pricing the collective expectations of a slightly less unknowable future—including inflation, growth and central bank policies.  

Other than Friday’s frenzy, the most notable event of the past week was Fed Chair Jerome Powell’s first Q&A session following the publication of his first Fed forecast. Along with what appeared to be a slightly more hawkish set of forecasts, Mr. Powell was clear, cautious and concise – another source of comfort for observers primed for the unexpected over the past year and a half.

Factoid of the week: US corporate high-yield spreads were 3.52% as of March 26, 2018; the equivalent for the Euro area was 3.14%. That positive differential is just over 37 basis points; on Feb 11, 2015, the day Dr. Yellen’s Fed conceded it might be too early to tighten, the differential reached 2.563%.
 

On the Rise: China’s Yuan

With the focus on trade with China at the heart of much of the tussle over tariffs, it’s noteworthy that the yuan has been on the rise since the beginning of 2017. This week, the currency is just about at the level right before it fell from about 6.2 per U.S. dollar to 6.4 as the formula for the daily price fixing was adjusted to include a basket of currencies that reduced the weight of the U.S. dollar. Tuesday’s daily fix was at 6.2816 yuan per U.S. dollar.

 

Source: Bloomberg, March 27, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The world was quite different in August 2015, when the band was reset.  China faced criticism from abroad that its currency was an element of its industrial policy, keeping its manufacturing prices low in an attempt to boost market share. In 2018, the debate is less about suppressed currency than about specific export products – especially as the currency continues to appreciate.
 

On the Slide: A Link Between Stocks and Bonds

A hallmark of financial markets in crisis has been the correlation across asset classes – making investors leery of the benefits of diversification – sometimes when those benefits are needed most. That applies as much to volatility as it does to asset prices.

 

Source: Bloomberg, March 27, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

But this year has been marked by a near disappearance of the correlation between volatility itself – at least across U.S. equities and U.S. fixed income.  As of March 27, 2018, the 120-day correlation between the CBOE VIX Index and the MOVE Index for fixed income reached 0.037, indicating almost a complete lack of relationship between the two over the previous 120 days. That’s a startling figure, suggesting that each might have been serving as a buffer from volatility of the other – at least over the past 120 trading days. The correlation was at 5-year high as recently as August and September of 2017, reaching a level of 0.614 – substantially higher than during the 2007-8 financial crisis.  Another spike, to 0.5874 was reached in August 2011, as the U.S. was downgraded by Standard and Poor's in the midst of a political showdown.

 


Definitions:

Spread is the difference in yield between two different types of fixed income securities.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

The Merrill Lynch Option Volatility Estimate (MOVE) Index is a yield-curve-weighted index of the normalized implied volatility on 1-month Treasury options for the 2, 5, 10, and 30 year maturities

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.

 

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Diversification does not guarantee a profit or protect against loss.

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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