Head of Fixed Income Strategy
Summary: We expect the Treasury market to remain stable this week, offering an opportunity to watch at what is happening in credit space. Junk bonds are about to recover losses inflicted by the Covid-19 pandemic, as the market is eagerly looking at higher-yielding securities. In Venezuela, rum maker Santa Teresa might set a cap to riskier EM corporate bond yields. In the meantime, in Europe, the negative-yielding pile of debt is getting bigger with Portugal consolidating ten-year sovereign yields below zero. Expectations are high surrounding Brexit, and a hard Brexit is not to be ruled out, yet.
The bond market doesn't seem to bite to the reflation story as of yet. Low activity is regular during thanksgiving week; still, expectations for a bear steepener were high after news that the former Fed's Chairman Janet Yellen had been picked for Treasury secretary by president-elect Joe Biden. Even though we have seen some steepening materializing in the 5s30s last week, this week, we see the Treasury curve retracing slightly. It looks like the market is focusing on short-term data such as rising Covid-19 cases and the non-farm payrolls coming up on Friday. Powell and Mnuchin testify before the Senate Banking Committee tomorrow and before the House Financial Services Committee on Wednesday. The testimony might shed more light on Treasury Secretary Steve Mnuchin's decision to pull the plug on Fed lending facilities for mid-sized borrowers and cash strapped municipalities.
While Treasuries remain stable, it is worthwhile to pay attention to the high yield credit space. The CDX high yield spread is on its way to falling below 300bps, recovering the losses inflicted by the Covid-19 pandemic. According to Bloomberg data, year to date, junk bond issuance amounted to $406 billion versus $288 billion over the same period last year. Lower rated corporates have taken advantage of lower rates and market appetite for higher-yielding securities. Last week, Venezuelan rum maker Santa Teresa was rumoured to be looking to issue hard currency bonds; however, it didn't hit the market yet. This bond issuance is important because it would be the first private company in Venezuela to issue debt in US dollars since the '90s. Moreover, and it can reveal market appetite for riskier credits, setting a vital yield reference in the emerging market corporate space.
In Europe, we saw the 10-year Portuguese sovereigns falling below 0% in yield last week. Even though Portuguese government bonds yields closed the week slightly positive, we will most likely see them consolidating below zero. Spanish 10-year Bonos are next in line to fall in the negative-yielding territory, probably doing so by the end of 2020. Overall we remain positive on the periphery as the ECB gets ready for the last monetary policy decision of the year on Thursday, the 10th of December. In the periphery, we remain bullish the 30-year Italian BTPs which trade rich compared to their peers and will most likely benefiting from a tightening of the spread between BTPs and the Bund. Suppose Italy's GDP numbers come worst than expected tomorrow - in that case, we will see the BTPs falling. Volatility might offer an opportunity to investors that haven't entered this trade yet to get in slightly cheaper and to run the rally expected to spur from ECB's dovish policies.
Lastly, Brexit talks this week are taking centre stage as the country is set to leave the bloc by the 1st of January. Even though a deal looks to be in sight, experts are saying to get ready for a hard Brexit turn of events are not unlikely.
Economic Calendar:
Monday the 30th of November
Tuesday the 1st of November
Wednesday the 2nd of December
Thursday the 3rd December
Friday the 4th December
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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.
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