Fixed income market: the week ahead

(2) Emerging markets - IMF spring meeting

Expect a lot of talks about the emerging markets this week as the IMF meeting unfolds. As mentioned above, a recent report highlights the risk that if the Federal Reserve unexpectedly signals inflation concerns, it could trigger a selloff in the EMs space. The report calls for "clear central bank communication" to avoid a scenario such as the feared "taper tantrum". We suspect that there is an understanding of how dependent emerging markets have become on debt in the past five years behind the report. Indeed, developing countries have seen lower interest rates in the US as an opportunity to issue cheap US dollar debt, gearing themselves up. Suppose yields continue to rise in the United States, and the US dollar doesn't devalue. In that case, EMs might run into severe refinancing and default risk, which would cut them out from lifeline funds.

We have been vocal about the importance to create a buffer against rising yields in the United States by seeking coupon income. High yield corporate and emerging market bonds can provide such a  buffer. When looking at the EMs, local currencies can contribute to the bond's total return by adding currency risk premia. However, let's look at bonds performance in the first quarter of the year (see chart below). On average, bonds across all currencies provided negative returns, except for Chinese renminbi bonds. The problem stems from the fact that a recovery in the EMs will diverge from the one in advanced economies due to vaccination pace. Additionally, developing countries have limited fiscal stimulus potential. Outflows from EM bond ETFs are accelerating as investors realize that emerging market risk rises together with US bond yields and the danger of a "policy surprise" from the Fed. However, the good news that the cheaper EMs bonds are getting, the better opportunity is for investors to pick some of these up. Indeed, economic recovery and higher inflation in the US should positively impact EM debt as soon as the fear of monetary policy mistakes diminishes.

(3) Rotation from European sovereigns to US Treasuries

Countries in the European Union are waking up fast from Easter's lull, realizing that their cost of funding is increasingly rising. It may be the reason why we have a busy sovereign auctions' calendar. Austria, Spain, France and the United Kingdom will issue long term bonds. Among these, the Spanish 20-year and French 30-year bond auctions on Thursday are extremely important. They will provide better insight into investors' appetite for ultra-low yields in the euro area as US Treasuries become more attractive. Just a couple of months ago, France saw record bids (75 billion euros) for the issuance of 7 billion euros of bonds maturing in 2072 (FR0014001NN8). Those bonds have already lost 15% in value, and they look poised to fall even further as it becomes clear that the European Central Bank might not have the tools to slow down the rise in yields. The ECB has been vocal about rising bond purchases under the PEPP. Still, the market is starting to understand that the PEPP has important limitations, such as its capital allocation and the scarcity of Bunds. We believe that things will become worst for the ECB as rotation accelerates and demand for European sovereigns, especially the periphery, will decrease. Tomorrow we will follow up with an in-depth analysis of this issue. Stay tuned!

Economic Calendar:

Monday, April the 5^th – Easter Monday

• Australia: TD Securities Inflation
• United States:  Markit Services PMI, ISM Services PMI (Mar), Factory Orders

Tuesday, April the 6^th

• Japan: Overall Household Spending
• China: Caixin Services
• Australia: RBA Interest Rate Decision, RBA Rate Statement
• Italy: Unemployment
• Eurozone: Unemployment Rate
• Austria: 10- and 30-year bond auctions

Wednesday, April the 7^th

• Australia: Commonwealth Bank Services PMI
• Japan: Leading Economic Index
• Spain: Markit Services PMI
• Italy: Markit Services PMI
• France: Markit Services PMI, Markit Services PMI Composite
• Germany: Markit Services PMI, Markit Services PMI Composite, 5-year Bond Auction
• Eurozone: Markit Services PMI, Markit Services PMI Composite, G20 Final Press Conference
• United States: Good and Services Trade Balance, FOMC Minutes, Fed’s Evans, Kaplan, Barkin speak
• Canada: International Merchandise Trade, Ivey Purchasing Managers Index
• United Kingdom: RICS Housing Price Balance

Thursday, April the 8^th

• Japan: Current Account
• Germany: Factory Orders
• France: Trade Balance
• Spain: 3-, 5-, 7- and 20-year Bond Auction
• France: 10- and 30-year Bond Auction
• United Kingdom: 10-year Bond Auction
• Eurozone: ECB Monetary Policy Meeting Accounts
• United States: Continuing and Initial Jobless Claims, Fed’s Powell speaks at IMF, Fed’s Bullard and Kashkari speak

Friday, April the 9^th

• United States: IMF Meeting, Producer Price Index, Fed’s Kaplan and Harker speak
• China: Consumer Price Index
• Switzerland: Unemployment Rate
• Germany: Trade Balance, Industrial Production
• Canada: Unemployment Rate, Participation Rate, Average Hourly Wage, Net Change in Employment