Trump & Temer trades: back to start

Mid-Week Bond Update

Trump & Temer trades: back to start

Global bond markets were mixed over the past five trading days as they were hit by renewed political uncertainty in the US and Brazil, by protracted unconvincing economic data in the world’s largest economy and a surprise credit downgrade in the second – China. When markets thought...

that political risk had fallen after the failure of populist parties in the Dutch and French elections, US and Brazilian presidents Trump and Temer were both caught in political scandals. This diminished expectations of a prompt delivery of their promises, causing a re-rating in the asset prices that had quickly priced in change, such as the US dollar and the real. Traditional safe-havens, such as long US Treasuries and the yen, rose. The US 10 year Treasury yield fell to 2.28%, down from 2.41% earlier this month.

Emerging Markets (EMs) suffered from Brazil’s instability, although the asset class showed more resilience than in previous crises. The Mexican peso and the Russian ruble rose against the greenback over the past five trading days, buoyed by surging commodity prices. Oil remained above US$ 50 per barrel on hopes that the Organisation of Petroleum Exporting Countries will on Thursday extend its planned output cuts. European Central Bank (ECB) president Mario Draghi also underpinned global financial markets by reiterating the ECB’s continuous monetary support. His comments quelled market fears about a potential European “taper tantrum,” referring to the market sell-off suffered in the US after the Federal Reserve (Fed) first announced in 2013 that it planned to reduce its stimulus. Speculation about the withdrawal of European support has increased on the back of improving data and ahead of the next ECB meeting on June 8.


ON THE RISE

Euro trading – follow the leader: The European currency rose to its highest level against the US dollar since September last year, boosted by improving data, mostly from the region’s leading country. German’s IFO index of business confidence rose to 114.6 in May, above expectations of 113.1, while the country’s strong manufacturing sector pushed the Euro-area May manufacturing Purchasing Managers’ Index (PMI) to 57, ahead of forecasts of 56.5. German exporting companies have benefited from a low currency since the ECB first unveiled its stimulus two years ago – pushing the country’s current account surplus to 8.5% of Gross Domestic Product (GDP), near the 8.9% reached in June last year, the highest since at least 1971. Despite an improvement in Spain and other European economies, it is the German lead that mostly drives the common currency’s trading, as shown on the chart.

 

What happened to the European gloom?

Currency and activity are on the up

Source: Bloomberg as of 24 May 2017. PMI is Purchasing Managers’ index. RHS is right hand side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

High Yield – beyond oil: The premium that investors pay to hold higher yielding but lower rated US corporate bonds fell to 360 basis points (bps), the lowest since early March, as relatively stable oil prices kept the energy sector’s default fears at bay. However, and unlike recent years, it is not Energy that is driving High Yield (HY) performance, but the Pharma and Health Care industries, up 8.3% and 6.9% so far in 2017, mostly driven by rising corporate profits. Asset managers and banking HY bonds have also performed strongly, up 6.6% and 5.9%, respectively, on the back of an improving economy and president Trump’s promises of looser regulation. Improving economic growth and the Fed’s commitment to a gradual increase in interest rates give HY a sweet spot as financing costs remain low but growth is high enough to lift profits.

 

ON THE SLIDE

Trump trade – back to start: Vindicating those, such as Western Asset, who believed that president Trump’s growth plans would take a while to come into fruition, markets now seem to back such a view. Either because of political scandal, lacklustre data or plain disappointment, the fact is that leading indicators have now fallen back or are closer to their level in November, as seen in the chart. Over the past 5 trading days, housing data has also dropped in line with the weak first-quarter growth and recent inflation figures: in April, new home sales fell 11% to 569,000 over the previous month, well below expectations of 610,000. Existing home sales also dropped to 5.57 million in April, below estimates. This is keeping the yield of the Treasury 30-year bond under 3%, something only seen in 2008, in the midst of the financial crisis; in 2014/2015, when the European sovereign debt crisis rattled markets, and in 2016, following Britain’s decision to abandon the European Union. US inflation expectations have also fallen to election-day levels. Click here to read why Western Asset has held a cautious view since soon after the November election.

 

Trump trade – getting real

Source: Bloomberg as of 24 May 2017. UST is US Treasury; USD is US dollar; RHS is right hand side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.

 

Brazil – little contagion: Allegations that president Temer could have supported the bribery of an imprisoned former politician sent Brazilian stocks, bonds and currencies tumbling, igniting stop-trading mechanisms. Less than one year after taking over from his impeached predecessor Dilma Rousseff, Temer’s promises of pension and other reforms could now be in jeopardy as he battles the allegations. Markets soon repriced the new scenario, although hopes that the country could activate its now more stable and reliable public mechanisms helped mitigate the losses. The yield of the 10-year US dollar-denominated sovereign bond has now fallen back to 4.85%, after shooting to 5.04% last week. The real has also recovered almost half of the lost ground. While leading EM indices were dragged down by the news in Brazil, the sector has been more resilient than in previous crises. Local bonds of oil and commodity-exporting countries, such as South Africa and Indonesia, returned more than 0.6% over the past five trading days, while the Mexican peso rallied to 18.5 units per dollar following a domestic interest rate hike.

 

Source for all data: Bloomberg and Barclays Capital as of 24 May 2017, unless indicated.

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