Thorny Valentine roses

Mid-Week Bond Update

Thorny Valentine roses

The much-awaited January US inflation report brought what many investors had wished for, rising inflation, but a busy Valentine day also delivered a gloomy and unexpected dip in the country’s retail sales. Investors focused on the former and most global bond asset classes continued the...

recent sell-off, with none of the 33 fixed income sectors tracked by Mid-Week Bond Update posting positive returns over the past five trading days. Long-maturity US Treasuries, usually more sensitive to inflation prospects, plunged 1.5%, taking their one-month loss to almost 5%. Emerging Markets (EM) also fared poorly, especially when translated into US dollar terms, as the greenback surged against most EM currencies.

US inflation expectations rose following the release of January’s inflation data – despite the disappointing retail sales figures and as oil, a major inflation component, continued to drop below US$60 per barrel, given increased supply. Some investors, such as Western Asset’s John Bellows, believe that the market’s inflation estimates might be too optimistic (click here to read his views). The yen extended its gains against a rising dollar, up 2.8% over the past five trading days. Some investors say the yen’s 5.3% year-to-date surge against the US currency is due to an attractive valuation, speculation about the country’s monetary stimulus being tapered soon, and also as the currency gains safe-haven status. This could become more prominent as the dollar could be dragged down by rising budget and current account deficits. Some investors, such as Brandywine Global, believe the dollar could be on a downward trend.



Emerging – Developed markets: rate decoupling? Brazil and Russia recently cut their leading policy rates, both as they try to ignite growth in their economies, and also after a disciplined approach has allowed them to bring down inflation. In Brazil, for instance, annualised consumer price growth has dropped to 2.8%, far below the double-digit figure it had two years ago. With rates at 6.75%, some investors believe there is room for further easing. Brazil and Russia’s latest cuts come as some developed markets, such as the US, the UK and Canada have already started a rate hiking cycle, following a decade of monetary stimulus. As seen in the chart below, Brazil, India and Russia raised rates in 2013 and 2014 in order to defend their currencies as the world-wide slowdown in growth and oil prices hit their economies. With global growth now picking up, some investors believe we could see a reversal in rate trends, with EM rates falling while those of developed markets increase. Click here to read more about potential opportunities in EMs, according to Western Asset’s Chief Investment Officer, Ken Leech.


Trend reversal? DM rates go up, EM’s. down

Developed Markets & Emerging Markets

Source: Bloomberg Barclays as of 14 Feb. 2018. The lines show the leading policy rate for each country. RHS is Right Hand Side. Please see disclaimers for definitions.


Rand - up after the sack: The South African rand rallied 3% against a rising dollar, over the past five trading days, after president Jacob Zuma resigned and was replaced by Cyril Ramaphosa, a former lawyer who has pledged to revive the economy and cut corruption. Zuma's party, the ruling African National Congress (ANC), had called a vote of no confidence in Zuma this week. Markets cheered the resignation as Zuma had had some tension with investors, particularly after the sacking of the popular Pravin Gordhan, the country’s former finance minister. 



US Retail Sales – Christmas, revisited: While most investors kept an eye on the much-awaited January inflation figure, it was Retail Sales that brought the surprise: the measure unexpectedly declined 0.3% in January and was significantly revised down for December (-0.5%). The news, and the fact that the drops were spread throughout most Retail categories, led some analysts to cut their first-quarter overall growth expectations as Consumption accounts for almost two thirds of the US’s Gross Domestic Product. While the more optimistic may blame the soggy Sales report to the freezing weather over the period, others believe the US economy is not as buoyant as it seems, with the labour market still affected by a low participation ratio, and inflation contained by long-term, secular forces such as technology, aging populations and low productivity. Data-dependent investors, and central bankers, continue to watch.


Inflation expectations rise, while Retail Sales and Manufacturing drop – too much optimism?

US Inflation

Source: Bloomberg as of 14 Feb. 2018. PMI is the Market US Composite Purchasing Managers’ Index. RHS is Right Hand Side. Please find definitions in the disclaimer.


High Yield – tough week: After an initial resilience to the sovereign bond sell-off, High Yield spreads have crept up as investors’ price in higher interest rates, which may cut corporate profitability. The spread over Treasuries of the Bloomberg Barclays US Corporate High Yield Index rose to 364 basis points (bps), from 311 at the end of January. The price that investors pay to protect themselves from default has also gone up, although not evenly: over the past five trading days, it rose, significantly for the Energy sector – given the drop in oil prices -, while it barely moved for Technology or Consumer Staples. Click here to read Brandywine Global’s view over the recent market sell-off.



Source for all data: Bloomberg and Barclays Capital as of 14 Feb. 2018, 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.