01 Jul 2019
Markets at a glance
Source: Bloomberg, Merrill Lynch, as at 24 June 2019.
Source: Bloomberg, Columbia Threadneedle Investments, as at 24 June 2019.
Macro / government bonds
Core government bond yields moved to new year-to-date lows as central bankers’ statements became more emphatic that rate cuts are likely to be more “when, than if” in the coming months. The US 10-year fell to 1.97%, a level last seen in November 2016.
The week started with European Central Bank (ECB) president Draghi saying that if the inflation situation did not improve, action would need to be taken (see Chart of the week). It was almost a repeat of the “whatever it takes” speech of July 2012. It was all that the market needed to move even more to a rate cut view and begin dreaming of asset purchases. German 10-year bunds yields quickly fell 5bps on the news. The FOMC followed a couple of days later, with its periodic meeting, keeping rates unchanged, but dropping the word “patience” from its usual comments, indicating increasing uncertainty and, citing that it would act, if necessary, to sustain economic growth. No more mention was made regarding the inflation fall being temporary. Even in Japan, the Bank of Japan said rate cuts could be possible. The Bank of England (BoE), which had been presenting a relatively hawkish view up to now, also indicated growing concern over the direction of the economy. The BoE amended its UK economy growth forecast to zero for the second half of 2019; however, it maintained a slightly hawkish bias as it kept rates unchanged this week.
In the background, Middle East tensions heightened on the news that Iran had downed a US drone and that the country would exceed international limits on uranium enrichment. President Trump considered retailiation but stood down at the last moment citing that it must have been a mistake.
More positively, news was released that Trump and Xi would meet at the G20. Nothing was resolved, as usual, but their meeting still calmed the markets regarding the trade war front.
In both Europe and the US, PMI figures generally came in weaker than expected. Only France and Germany’s figures beat expectations.
Investment grade credit
Investment grade credit spreads ripped tighter over the back half of last week after both the ECB and US Federal Reserve (the Fed) shifted to a more dovish stance. US credit outperformed even as US treasuries rallied, building upon the year-to-date excess returns. The Fed’s stress test for banks this week are likely to reveal that issuers will be permitted to increase their median pay-out ratio to shareholders from already elevated levels. US dollar investment grade new issuance slowed to $11.9 billion, down from $31.2 billion the previous week, and the seasonal primary market slowdown will likely continue as we enter earnings- related issuance blackouts.
In Europe, the ECB retained the possibility for further asset purchase programmes going forward. If the ECB does extend or launch a new Corporate Sector Purchase Programme (CSPP) programme, this would clearly provide further support to the market and indeed this is something that the market is increasingly pricing in. In credit specific news, French bank Natixis’ share price came under pressure owing to its majority stake in H2O Asset Management, which has seen over €1.4 billion outflows driven by fears of illiquid bond holdings in relation to a controversial German financier. In terms of supply, issuers are continuing to take advantage of ultra-low yields (e.g. the euro investment grade market yields 0.57%) with year-to-date global investment grade issuance running at over 18% higher compared to last year.
High yield credit
European high yield, alongside other fixed income assets, experienced a very strong week thanks to the ECB’s announcement about potential additional monetary stimulus. On the market rally, one of the biggest winners was Altice, a French telecom company, which saw its longer-dated bonds jump up after the news of a possible sale of its video-advertising service, Teads. On the other hand, the troubles in the auto sector continued. Jaguar Land Rover, a British auto manufacturer, saw its Moody’s rating drop to B1, with a negative outlook, because of negative cash expectations and a high leverage. There was a limited amount of activity in the primary market, with only a €200 million tap into an existing bond from United Group, a southern European media services provider. After a month of negative flows, the asset class experience a net inflow.
Municipal fixed income
Flows into the US municipal market softened modestly but remained positive, bringing the year-to-date total to $42.1 billion and marking the 24th consecutive week of inflows. New supply for the week was easily absorbed, with most deals multiple-times oversubscribed. Positive summer technicals, where new supply is typically outweighed by maturities and coupon income are expected to drive the market over coming weeks. In credit specific news, $10 billion of Los Angeles Unified School District debt was downgraded one notch by Moody’s from Aa3 to Aa2. Budget challenges for the second largest school system in the country worsened after voters rejected a new parcel tax earmarked to help close the district’s budget gap.
With the Fed delivering everything but a rate cut this week, investor attention will now shift towards resolution of trade disputes. Though not fully priced into municipal valuations, some regions are more exposed to protracted trade wars than others. California conducts more trade with China than any other state in the country, with 9% of its exports and 37% of its imports tied to China. Other states, though lower in US dollar amounts, have similarly high exposures by percentage of imports/exports – IL, TX, TN, and WA to name a few. To the extent negotiations at the G20 produce no tangible results, or worsening of trade conflicts, credit deterioration would likely force spreads wider for the most directly-impacted areas.
Asian fixed income
Asia credits had another week with positive total returns, helped by lower US treasuries and tighter spreads, on the back of the Fed’s dovish tone at the June FOMC.
The Ministry of Finance in Indonesia raised the 20% luxury tax threshold for residential non-strata title to IDR30 billion ($1.2 million) from the previous threshold of IDR10-20 billion – positive for property developers such as Bumi Serpong and Pakuwon Jati. Geo Energy Resources Limited announced that its subsidiary PT Tanah Bumbu Resources has resumed normal production and delivery of coal, following weather improvement. Moody’s downgraded Petronas from A1 to A2 but revised the outlook from negative to stable, because of the close linkage to the Malaysian government. It is thought that government intervention could be negative for its cash flow profile (dividend payments). Petronas is now rated one notch above the sovereign, versus previous two notches. Moody’s also downgraded Tata Motors from Ba2 to Ba3 (negative outlook), to account for the decline in the company’s financial profile. The credit rating of Tata Motor’s subsidiary, Jaguar Land Rover was also cut from Ba2 to B1 with a negative outlook, due to its weak operating performance in China and the risk of a “no-deal Brexit”.
The primary market saw $10.5 billion of issuances last week (prior week: $12.2 billion) and the year-to-date total supply was $154 billion (+25% y/y). New issues include China Railway Construction Corp, Korea Electric Power, Hopson Development, Greenland Global Investments and several LGFVs (Sichuan Railway Investment Group, Xi’an Municipal Infrastructure Construction).
Leveraged loans
US leveraged loan prices decreased modestly over the past week despite gains across other risk assets. This is not totally out of character for the sector, which tends to fall out of favour when the fear of rising interest rates subsides, which was cemented last week with a Fed dot plot that formally priced in future cuts in the Fed Funds rate. Leveraged loans are providing modest gains on the month, underperforming investment grade and high yield bonds. The percentage of loans trading above par is now just 9% with 45% between $99-$99.99 and another 15% between $98-$98.99. In terms of flows, retail funds reported a 31st consecutive outflow this week. CLO issuance totalling $61 billion year-to-date is only down 5.8% y/y from record levels set in 2018.
Emerging markets
Emerging markets were well supported by the dovish central banks’ comments this week as market participants reached for yield. The hard currency index spread tightened -16bps to 361bps, over the week.
Brazil and Indonesian central banks kept rates unchanged this week, but both indicated the possibility of rate cuts in the future, suggesting a matter of not if, but when the next rate cut would be.
Argentina’s economic picture continues to be dismal as GDP printed at -5.8%, keeping the country still officially in recession, with unemployment at 10.5%, a 13-year high.
In South Africa, another country officially in recession, restructuring of ESKOM, the electric company of the nation were the headlines. The restructuring of ESKOM’s capital structure will be in the area of ZAR 230 billion ($16 billion equivalent), which will also mean a transfer of debt from the corporate to the state. ESKOM bonds rallied strongly.
Trump zeroed in on Turkey this week as the US president threatened new sanctions against the country for buying a Russian missile defence system (delivery is expected in July). More bad news, domestically, for prime minister Erdogan as the reprised Istanbul mayoral election resulted in a loss by an even greater amount than the first time, for Erdogan’s political party, AKP,
New issues included a Sri Lanka $2 billion issue.
Commodities
Commodities were higher for the week, on the back of gold and crude oil but also with support from base metals as the Fed’s dovish talk gave a boost to the market. Geopolitical tensions helped move crude oil prices higher.
Crude was especially volatile this week, seeing its biggest weekly gain since February, as prices jumped as much as 6% in a day and then retracing sharply on the news coming out of the Middle East. Department of Energy figures showed crude oil inventories dropped by 3.1 million barrels, more than expected. A fire at an oil refinery outside of Philadelphia, which was completely destroyed, also helped push prices higher.
Gold climbed higher, rising 3% on Thursday, reaching $1,385 in the day, and then breaking up further to $1,411 before falling back and closing the week at $1,400.
Base metals, especially copper which was up 3% for the week, was higher on the news of the upcoming Trump-Xi meeting and expectation that the PBoC will ease rates.
Fixed Income Asset Allocation Views
24th June 2019
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