US dollar: Trump dump

Mid-Week Bond Update

US dollar: Trump dump

Comments by US president Trump about the dangers of having a strong currency sent the dollar back down to the level it had before the latest Federal Reserve rate hike in December. In a politically-driven week, Trump’s plans to withdraw from the Trans-Pacific Partnership (TPP) trade agreement also dragged...

the currency lower, given the expected lesser global trade. Emerging Markets (EM) currencies were the winners in such scenario, also boosted by soaring commodity prices. EM local bonds rose, buoyed by the currencies, unlike developed market sovereign debt, which was hit by positive data: December Purchasing Managers’ Indices (PMIs) and inflation in both the US and Europe were relatively firm, pushing up inflation expectations. The US 10-year breakeven rate (or the difference between nominal and inflation-adjusted real yields) reached 2.06% on Jan. 19, the highest in more than 2 years. China’s fourth-quarter economic growth, at 6.8%, was in line with expectations, and not in the hard-landing space that some investors feared.

Corporate bond returns were hit by the rising underlying risk-free sovereign base rates, although their spreads generally tightened. Over the past five trading days, the cost to protect corporate debt against default in the US, Europe and Asia fell. US non-agency Residential Mortgage-Backed Securities (RMBS) did well, supported by strong domestic housing starts – they were up 11.3% in December to a 1.23m annualised rate, above forecasts. US bank loans continued to deliver (they have gained 0.6% so far this year, and 12% over the past 12 months) on expectations that their traditional adjustable rate will increase if interest rates go up, as expected. Sterling rallied 1.35% against a falling US dollar after the Supreme Court ruled that Parliament needs to approve the law that will trigger Britain’s exit from the European Union (EU). Oil held at US$52 per barrel as increased US shale production offsets other oil producers’ output cut plans.

 

ON THE RISE

EM currencies: talk me up, talk me down: EM currencies have crept up over the past few weeks, boosted by stable oil and rising soft commodity prices. EM currencies have now almost reached the level they had before Trump’s US election victory in November, seen at the time as a negative for the asset class, given the new Administration’s protectionist stance. The narrative has now changed: Trump’s talk-down of the dollar has helped lift commodity prices – this happens because more dollars are needed to buy the commodities, and also because a lower dollar tends to make commodities more affordable, lifting demand and thus, prices. This backdrop boosted the currencies of commodity exporting countries, such as the Peruvian sol (+2.1% over the past 5 trading days) and the Chilean peso (+1.9%).  Both countries export copper, which has gained 7% so far this year; Peru also exports coffee (+12%). Latam local sovereign bonds were up 1.4% over the same period, more than any other EM region. Some investors believe EM currencies have further to go before they match the recent commodity surge (as shown in the chart below). Click here to know which opportunities Western Asset sees in 2017.

 

Mind the gap: EM currencies catch up with commodity rally

 

Source: Bloomberg as of 20 January 2017. RHS is Right Hand Side. EM is Emerging Markets. Please find definitions in the disclaimer.

 

Bond issuance – rush! US, European and Asian corporates have rushed to issue debt as global bond yields rise, hoping to lock in lower rates for the new few years. US investment grade corporate issuance so far this year is up 21% from the same period last year, while US high yield (HY) issuance has leapt 171% over the same period. Among HY issuers, Financial companies have sold more debt than any other sector, an improvement over the whole of 2016, when they lagged behind Consumer and Communications issuers. This is a reflection of the improved growth outlook, as banks and other financial companies are expected to profit from higher rates and increased lending. In Europe, Financials also lead this year’s issuance rankings, followed by Communications. Global companies have largely benefited from lower rates: the average coupon paid by investment grade-rated companies has plunged from 5.9% in 2002, to the current 3.6%.

 

ON THE SLIDE

China- US Treasury holdings: until rising yields do them part:  China’s holdings of Treasury bonds plunged in November to US$ 1.049 trillion, down from US$ 1.115 tn the previous month. The 6% drop is the biggest monthly fall since 2011. Much has been written about the rising tension between the new Trump administration and China over currency wars and trade barriers, but correlations show that China’s Treasury holdings are mostly (positively) correlated to the country’s own trade balance, as shown in the chart: the bigger the trade balance, the more foreign reserves to spare in foreign markets, and vice versa. China’s US Treasury holdings are also closely (negatively) correlated to US bond prices: as yields rise (or prices fall), holdings tend to drop – also shown in the chart. What few are talking about is the other side of this relationship: Chinese bonds’ foreign holdings. Click here to read Brandywine Global’s view on China’s onshore bond market.

 

US Treasuries-China: Up or out

 

Source: Bloomberg as 25 January 2017. UST is US Treasuries; y is year; RHS is right hand side. Please find definitions in the disclaimer.

 

Lira – no Turkish delight: The Turkish lira was the worst performing major currency against a falling US dollar over the past 5 trading days, down 2.2%, and taking its 12-month plunge to 21%. The drop came despite the central bank raising its overnight lending interest rate earlier this week, saying that it would tighten policy more if needed. The monetary authority has recently unveiled extraordinary measures to buoy its battered currency – a mirror of the country’s political instability following a coup attempt in July, weak growth, rising inflation and sensitivity to rising energy prices. A weaker dollar was welcomed.

 

Source for all data: Bloomberg and Barclays Capital as of 25 January 2017

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