Friday, January 4, 2019

Bond Vigilantes: "2019, fasten your seatbelts?"

From Bond Vigilantes, Jan. 3:
The new year has started with a blunt reminder of probably everything that investors wanted to forget over the holiday season: economic data is worsening while the oil price continues to fall, dragging down equities and the most equity-like fixed income asset classes. Traditional safe-havens continue to rally, as they did in 2018.
The year left behind ended far worse than it started: after a strong-growth 2017, where most fixed income sectors delivered positive returns, last year’s early hopes quickly sank with the escalation of the US-China trade war and the Italian elections in May, which raised questions about the future of the European Union (EU). Fears of a hard Brexit also weighed on the continent’s economic prospects, lifting credit spreads above those in the US for the first time in years. China continued its slowdown, while in the US, optimism started to fade as interest rates rose, economic data disappointed and oil plunged to less than $50 per barrel amid forecasts of weak demand. US corporate earnings projections were also reduced as the effects of the recent tax cuts started to decline. The world benchmark US 10-year Treasury yield, which reached a 7-year high of 3.2% last year, changed gear after the Democrats won control of the House of Representatives in the November mid-term elections. Investors believed that their victory reduces the chances of further tax incentives from President Trump. The 10-yr Treasury yield has been on a continuous slide since, ending 2018 at 2.66%.
Despite the pessimism, almost one third of the 100 fixed income asset classes tracked by Panoramic Weekly delivered positive returns last year, led by traditional safe-havens, such as German bunds and US Treasuries. With global growth slowing down and global debt reaching a whopping 225% of world GDP, investors are betting some central banks may have to rein in their rate hike projections – offering more support to bond prices. US Federal Reserve Chairman Jerome Powell already did in December – the Fed now sees 2 rate hikes this year, instead of 3. The M&G Panoramic Weekly team wishes you a very happy new year.

Heading up:
Safe-havens – the best of times in the worst of times: US Treasuries, European government bonds and Japan’s sovereign debt did in 2018 what they usually do: deliver positive returns, rain or shine. While corporate debt markets and developing nations suffered from higher interest rates, a stronger dollar, the ongoing trade wars and lower global economic growth, traditional safe-havens remained solid. Treasuries have only posted negative returns in 2 of the past 18 years (2009 and 2013), while European and Japanese government bonds have only missed 1 year of positive returns (2006 and 2003, respectively), over the same period. Sovereign bonds have been favoured by protracted global low inflation, a backdrop that may continue going forward given the recent plunge in oil prices. Weaker growth and rising global debt may also refrain central banks from tighter monetary policies: out of 19 major economic areas, 5 are projecting lower rates in 3 years’ time (the US, Mexico, the Czech Republic, Japan and Korea), compared to none barely 2 months ago, according to Bloomberg data. In terms of currencies, safe-havens have also outperformed, mainly the US dollar and the yen. As Dickens would have put it, for safe-havens, it was (is?) the best of times, it was (is) the worst of times; it was the age of wisdom, it was the age of foolishness…
China government bonds and loose policy – odd one out: China’s USD-denominated sovereign debt returned 3.8% to investors in 2018, the third best performer among the 100 fixed income asset classes tracked by Panoramic Weekly. The rise comes despite a slowdown in economic growth, now down to an annualised pace of 6.5%, from 6.9% last year. The country’s manufacturing PMI dropped to 49.4 in December, the weakest since 2016 and below the 50 level that marks a contraction. Yet, the Chinese government’s stimulus policies, including cuts in the banks’ reserve requirements, continue to support the economy and the bond market. Still mostly in the hands of local investors, Chinese debt is increasingly available to foreign holders via the Bond Connect programme, and may be more in demand after it is included in some Bloomberg Barclays benchmark indices from April this year. In the present global rate rising environment, investors welcome a country with an overall easing policy.

Heading down:  
Business cycle – down-sloping? With the last recession now a decade ago and economic theory suggesting that cycles tend to last about 10 years, investors are understandably concerned – hence their preference for safe-havens over risk assets....