Greed and fear drives financial markets and investor risk appetite has returned after a bout of extreme pessimism at the start of February. The VIX index of volatility remains in the low part of the range and the S&P is trading just off its all-time high reached earlier in April despite US earnings forecast to fall (-6.1% yoy according to Thomson Reuters). Increased risk appetite is also prevalent in fixed income markets with the high yield and energy sector having rebounded but also seen by strong investor uptake in the new issue market.
Investors have welcomed ‘serial defaulter’ Argentina back to the market: the issue size was up-scaled to USD 16.5bn and yields were tightened to a range from 6.25% for 3 year maturities, 7.5% on the 10 year and 8% for the 30 year. The order-book for the issue was close to USD 70bn. While we remain positive on the new Macri led administration, for us the issue does not offer enough upside; the 7.5% 2026 issue at trades on a spread of 518 basis points over Treasuries which is where we would expect for a B1 rated credit of equivalent duration to trade. Argentina’s long-term foreign rating has been upgraded to B3 by Moody’s but the market is already pricing in further improvement.
That said, we do see opportunities in certain high quality issues which offer a positive yield. This week Abu Dhabi returned to the market after a 7 year absence issuing USD5bn of US dollar bonds split between 5 and 10 year maturities. Given this Aa2 rated credit’s rarity value and the positive yield, this issue was easily absorbed by the market. The 3.126% 2026 tranche trades ~3 notches cheap on Stratton Street’s valuation models. We also like this issue as we favour a portfolio targeting high quality credits at the long end of the curve given the prevailing uncertainties in the world.
Global growth remains anaemic with policy over-reliant on central banks and weak global aggregate demand risks central bank easing becoming a game of competitive devaluation with no real winner. The declining velocity of money implies QE has had limited success in promoting growth in the wider economy. The IMF and OECD, along with others commentators, warn that fiscal policy and structural reform is being underutilised. Although China is a likely exception to this but faces the challenges of greater structural reform and controlling credit growth and debt levels.
US growth expectations have been tempered since the start of the year and expectations for interest rate rises have been cut back. Yesterday’s US Q1 GDP data showed the economy only expanded 0.5% on a quarterly annualised basis with ‘sluggish consumption’ growth of 1.9% and business investment falling 5.8%. While the jobs data has been strong it is yet to translate into meaningful wage increases. For the average consumer wage increases are important drivers of confidence and increased discretionary spending but US real median household income has declined since 2007. Europe and Japan continue to struggle, despite the BoJ and ECB having slashed rates and ventured further into the realms of unconventional policy with negative rates; limited support from fiscal policy and structural reforms means growth continues to disappoint. Globally, inflation still remains subdued and there was even talk of Australia flirting with deflation after headline inflation fell -0.2% qoq, although it remained positive on a year on year basis at 1.3%.
Insipid growth and elevated debt levels limit scope for central bank tightening and continues to support fixed income markets. Even if another US rate rise is warranted later this year we expect the Fed will remain ‘ahead of the curve’ and the yield curve will flatten favouring positioning at the long end on a duration weighted basis. High quality Eurobonds offering positive yields, particularly from ‘wealthy nations’, look compelling investments.