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Has the Bond bull market run out of steam?
| 02-11-2016 | Lionel Pavey |
The yield on Dutch 10 year government bonds has increased sharply in the last month (October 2016) –from 0.02% at the start of the month to 0.28% at the end – bond prices of course move in the other direction and have gone down. Why?
Possibility that the Federal Reserve will raise rates in America? Uncertainty over when the ECB will end their QE programme and the knock-on effects in the market?
ECB president Draghi has not said if the programme will end in March 2017 as originally envisaged. As monetary policy has not delivered the boost to the economy that was expected, maybe it is time for Government to look at changes to the fiscal policy via a Keynesian stimulus leading to lower taxes and an increase in direct government spending.
So if the bond market has reached the bottom and prices will start to rise, what will be the consequences?
The ECB is holding over EUR 1 trillion worth of bonds – can they unwind this position? Immediate selling would lead to a collapse in prices and a large increase in interest rates – deflating an already fragile economy and withdrawing liquidity from the financial system. Could the debt be monetized – the scale involved has never been seen before, so difficult to say.
But, what will happen to bond prices when yields start to rise?
If the yield on 20 year government bonds in the EU was to increase by 2% from their current levels, this would lead to a fall in price of 25%. If the yield on 30 year government bonds in the EU was to increase by 3% from their current levels, this would lead to a fall in price of 44%.
As the ECB would have to sell their existing bond holding at lower prices, there would be a huge loss on their portfolio – who ultimately would have to bear this loss?
What would be the effects on the equity markets – there has to be a knock-on effect if bond yields rise leading to a fall in equity prices. Is the current fragile market able to absorb these transactions – is there enough liquidity in the market?
Very worrying times ahead – companies will have to review their funding strategies, but this can lead to opportunities.
Lionel Pavey
Cash Management and Treasury Specialist – Flex Treasurer
Will the Fed kill the EM currency rally, or will Trump?
| 01-11-2016 | Simon Knappstein |
The USD is strengthening again broadly across the range. As it had weakened since Q1 this year versus EM currencies, this trend now seems to have come to a halt. Obviously the expectation that the Fed will almost certainly raise interest rates in December is the major factor for this move. What also may be of importance here is the nascent notion that the expansion in global liquidity that has characterized financial markets for so many years might have come to an end. Both the ECB and the BoJ seem less willing and/or have less room to increase QE.
This tends to direct investment flows away from EM currencies, and to a lesser extent from EUR and JPY, into the USD. So expect a stronger USD into year-end. And possibly even more in case of a Trump win, as protectionism will hurt global trade and that will hurt other currencies more than the USD. According to ING MXN, CAD, GBP and AUD would be among the currencies that would be hurt most relatively.
Here is a summary describing the consensus-view on a number of currencies. You can find more information and details on consensus FX forecasts in my latest October report.
Developed Markets
The Fed appears set to raise rates again before 2016 comes to a close. The USD is strengthening broadly; expect this to continue in the run-up to year-end. The USD is likely to peak when rates are finally lifted again in December. With a Fed hike likely to come before year-end and questions regarding Eurozone bank stability looming, the outlook for the common currency is becoming slightly bleaker. Over the remainder of the year, the EUR is likely to fall out of favor with investors.
For GBP, the likelihood of a so-called ‘hard Brexit’ has increased. Such a scenario increases the chances for another rate cut by the BoE during the remainder of this year. Expect downside pressure to prevail for the next couple of months. Oil prices boost the CAD, but still the outlook for a weaker CAD near-term hasn’t changed.
The JPY is not weakening on BoJ measures; only USD strength is pushing USD/JPY higher. External factors are the main drivers for JPY weakness. Stronger-than- expected commodity prices are the major factor keeping the AUD elevated. A weaker AUD looks more likely from here.
Emerging Markets
The RUB seems less sensitive to oil price shifts. High carry is providing support in risk-on circumstances. TRY has weakened on capital outflows on the back of a ratings downgrade. Geopolitical risks will weigh further on the TRY.
Latam
The BRL continues to trade with a positive momentum on the back of fiscal reforms by the interim president Temer and also by a high carry. The MXN has proven vulnerable to portfolio outflows. Rate hikes have given little support. A Trump win might push USD/MXN above 21.
Asia
CNY is weakening against the USD as the Fed is expected to raise rates. PBoC will verbally support the CNY but depreciation trend will continue. INR looks stable through the transition to a new RBI Governor. Still supported by a relatively high carry.
The end of the Notional Pooling Era: What to do next?