The Daily Update - BoJ, ECB, Volitility/ Seco and Qatar

Once again, the Bank of Japan (BoJ) left its policy unchanged, as expected by markets. The central bank kept the policy rate at -0.10% and JGB purchases at ¥80 trillion a year, to keep 10-year yields around 0%. Similarly, ETF and J-REIT purchases will remain at ¥6 trillion and ¥90 billion, respectively. The BoJ reiterated that it will maintain its QQE policy stance with yield curve control to achieve its targeted 2% inflation.

At the same time, the central bank raised its assessment of the economy until FY 2018 owing to greater resilience in private consumption. However, the BoJ lowered its CPI forecasts for the next three years. The BoJ has now delayed the timing of reaching the 2% target as a rise in medium to long term inflation expectations has been lagging. It now anticipates annual CPI to reach 2% around FY 2019, the sixth time they have pushed out their expectations. Who said patience is a virtue.

Overall, the BoJ believes that risks to the economy and price outlook are still skewed towards the downside and price momentum is still not sufficiently firm. It also noted that wage and price setting stance by firms continues to be cautious. We await the ECB later today and President Draghi’s statement after their two days of meetings, we don’t expect very much new information to be forthcoming.

Elsewhere, the volatility in bonds continues to fall, the Merrill Lynch MOVE Index which calculates the weighted average volatilities on the one month Treasury options on the 2, 5, 10 and 30 year US Treasury benchmark bonds hit all-time lows yesterday, at 48.25. This Index has been running since 1988. Equally the VIX index, which measures volatilities in S&P 500 index options, closed below 10 for the 5th consecutive day, the longest such run since the data started in 1990.

In our markets the recovery in Middle Eastern bonds continues with Qatar sovereigns once again trading higher. If we look at the 6.4% bonds maturing 2040, they are now 5 points off the recent lows and only two points off this year’s peak in pricing during early June. Saudi bonds are also performing well with our favorite Saudi Electricity (SECO) 5.5% maturing 2044 within 50 cents of the two year high in pricing at $109, a rally of 8.5 points this year. Although these bonds have performed well, we calculate that they still offer good value. The Qatari bond has an expected return and yield of 17.87% and has the potential for a 100bps further contraction of the spread to make fair value, not bad for a Aa3 credit, although there are obvious political risks to be taken into consideration. The SECO bond’s expected return and yield is ~21%, attractive for an A2 rating and this bond offers a further 112bps of spread contraction to reach fair value, again an asset to any risk-adjusted balanced portfolio.

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