The sanctioned five

Mid-Week Bond Update

The sanctioned five

Most global Fixed Income markets rallied over the past five trading days as geopolitical tension around North Korea’s nuclear programme intensified: US president Trump threatened to sanction any country trading with the Asian nation - a list that includes China -, while already-sanctioned Russia warned against the effectiveness of economic punishment. The already-sanctioned list also includes Syria, Iran and Qatar, whose conflicts remain unsolved. The rising tension sank US Treasury yields...

with the benchmark 10-year note falling to 2.072%, the lowest since Trump won the election in November. The US dollar dropped to a 17-month low, also undermined by a weak August jobs number and lower-than-expected wage data. Market-implied probabilities that the US Federal Reserve (Fed) won’t raise interest rates in December rose to 64%, up from 47% in July.

Emerging Market (EM) debt rallied, boosted by stronger EM currencies against a weak dollar, but also as the asset class is becoming more independent and less correlated to US markets, as seen in the chart below. EMs were also supported by improving fundamentals: Russian inflation reached a record annualised low of 3.3%, igniting speculation of further rate cuts. The ruble strengthened 1.9% against the US dollar over the past five trading days. South Africa’s economy posted annualised 2.5% growth in the second quarter, exiting its second recession in almost a decade. EMs were also underpinned by China, whose Manufacturing Purchasing Managers’ Index (PMI) rose to 51.7 in August, above forecasts of 51.3. EMs also benefited from recovering oil prices, which reached US$49 per barrel, up from $46 last week.

 

ON THE RISE

Yuan – the new safe-haven? China’s currency continued to strengthen over the past five trading days, adding 1% against the US dollar and taking its year-to-date gain to 6.3%. China, which has suffered US criticism for sustaining a weak currency in order to boost exports, is seeing its currency become more and more correlated to safe-havens such as gold, even more so than traditional sought-after assets in times of trouble such as the yen. China is trying to position the yuan as a major international currency, mirroring the country’s weight in the world economy. Its efforts seem to be bearing fruit, also despite the central bank’s attempts to cool off a booming domestic credit market. China’s growth stayed at an annualised 6.9% in the second quarter and has held near that level since breaching under 7% two years ago. The resilience of China’s economy is supporting other EMs, especially those that export commodities to the country, such as Chile – whose currency has soared 8.2% against the greenback so far this year.

 

Yuan: catching up with gold

Source: Bloomberg 6 September 2017. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

High Yield – clean (default) sheet: US High Yield bonds gained 0.4% over the past five trading days, coming back into positive territory following previous losses earlier this month. The asset class was boosted by the lack of default activity in August – the first month of no defaults since January 2014, according to JP Morgan’s Default Monitor. This followed a single default in July, totalling $471m, previously the lowest monthly volume defaulted since March 2015. US High Yield spreads over Treasury yields, closely correlated to the asset class’ default rate, fell to 380 basis points, down from 390 two weeks ago.

 

ON THE SLIDE

EM debt – its own way: The correlation between EM sovereign, US-dollar denominated debt and the US dollar itself has fallen to levels not seen since last summer, and is approaching the zero level that indicates the two variables are barely correlated at all. This has happened on the back of a weaker US dollar, but also as some EM governments and central banks gain credibility among investors. Mexico, for instance, recently raised its growth forecast and cut its inflation estimate at the same time. Its US dollar-denominated bonds are up 12% so far this year. Brazil’s have gained the same amount, helped by a rate-cutting cycle that some say still has further to run: Brazil’s inflation has fallen to 2.4%, the lowest annual rate since 1999. Click here to read why Western Asset Chief Investment Officer Ken Leech thinks that EMs offer some of the best investment opportunities at present.

 

EM debt and US dollar: til zero-correlation do they part

Source: Bloomberg as of 6 September 2017. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

India – elephant pace: The rupee was one of the few EM currencies to lose ground against the US dollar over the past five trading days, dragged down by disappointing second-quarter Gross Domestic Product growth, which printed at an annualised 5.7%, below the previous quarter’s showing of 6.1%. The slowdown was attributed to recent domestic economic shocks, such as the withdrawal of big-amount note bills, an effort aimed at bringing more transparency to the system. Manufacturing remained weak, growing only at an annualised 1.2% pace, a five-year low. The country is still attracting foreign inflows into its domestic bond market as its local, sovereign 10-year bonds, for instance, offer a yield of c. 6.5%.

 

Source for all data: Bloomberg and Barclays Capital as of 6 Sept. 2017, unless indicated.

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