Head of Fixed Income Strategy
Summary: We find that the summer government bond rally did little to tighten corporate bond spreads further. In the United States, we begin to see signs of distress from the money market space as Congress hasn't reached an agreement regarding the debt ceiling. In Europe, despite the recent selloff, EUR-hedged US Treasuries still offer a pick up over the majority of European government bonds.
Ten-year US Treasury yields plunged 65bps during summer from their April’s peak. If non-farm payrolls exceed expectations this Friday, we expect them to rise to 1.5% ahead of the September FOMC meeting. If jobs miss expectations, Treasuries have the potential to rally again and 10-year yields to fall to test support at 1.12% with the potential to plunge to 0.99% before resuming their rise.
In August, ten-year Treasury yields rose for the first time in four months. Yet, volatility remains flat and in line with the five-year average.
The Reverse Repurchase facility (RRP) receives record demand almost daily. It shows that liquidity in the money market space is high and continue to compress yields in the front part of the yield curve.
An explanation to the high volumes in the RRP facility can be that the Treasury General Account (TGA) dropped from $1.8 trillion to $258 billion as congress failed to extend of lift the debt ceiling. The TGA is crucial, because according to Bloomberg Intelligence, if an agreement is not reached the Treasury would face bankruptcy as early as November. The later an agreement on the debt ceiling is reached, the faster the Treasury will need to issue debt in order to refinance existing securities. Hence the market faces the risk of a Quantitative Tightening as a wall of bond issuance will hit the market.
Money markets begin to show signs of distress surrounding the debt ceiling issue. The spread between 4 and 6-week T-Bills continue to widen as the maturity of the Bills approaches an eventual bankruptcy. The 8-week Bills now offer even a pick up over the RRP facility.
The US yield curve continues to remain flat compared to the first half of the year, yet we expect it to steepen in autumn. The 5s30s is most at risk as 30-year yields will most likely rise above 2.4% by year end, but the 5 year will most likely stability around 1%.
Bunds have been closely correlated to US Treasuries. Ten-year Bund yields dropped roughly 25bps since the beginning of July until the end of August. Of that drop, around 20bps can be attributed to falling yields in the US, while 5bps are related to a slow down of the economy. Thus, we expect Bund yields to rise as soon as rates begin to soar in US, and the German election to accelerate this trend.
German Bunds show that the market believes that inflation is transitory in Europe. Indeed, the reaction of Bund was muted amid the highest German CPI reading in 13-years. Investors’ focus might be on the monthly inflation numbers which came out to be the lowest since November last year.
Following August’s selloff, Italy and Greece are the only European countries offering a pick up above EUR-hedged US Treasuries (0.61%). All other European sovereigns offer much less, continuing to expose European government bonds at risk of rotation.
We expect the BTP/Bund spread to tighten to 75bps before year end, as the country will benefit from political stability, contributions from the EU recovery fund and better European integration.
Good news from the US Corporate space: companies have been deleveraging since the second quarter of 2021. Yet, the yield that the lower rated junk bonds offer is the still the lowest in history.
The spread between HY and IG corporate bonds OAS widened slightly in summer, but still remains among lowest since 2007. At the moment investors get paid only 200bps over high grade bonds to hold junk.
The spread between Asian high-yield corporate bonds and US junk bonds has widened to the widest level in eleven years. Asian junk corporate bonds now offer around 532bps over US junk bonds. Beware! A lot of the Asian high-yield name are involved in real estate such as Evergrande and Fantasia Holdings.
It is a tough year for high-yield ETFs. They have recorded outflows every single month since the beginning of the year except in May. Despite the tight spreads, high grade ETFs have recorded inflows for four months out of eight.
The European corporate bond space is depressive. However it’s be interesting to note that despite European sovereign bonds have been volatile through 2021, EUR junk corporate bonds have tightened from offering 3% in yield at the beginning of January to currently offering 2.48% in yield.
Looking at the bright side, leverage of European companies has decreased sensibly and it’s now back to levels of March last year.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
