The Daily Update - Fed, Norway SWF

Yesterday, Stanley Fischer, the Fed's vice chair offered his resignation from the board citing personal reasons. Fischer had taught prominent figures such as ex-Fed chair Bernanke and ECB President Draghi, also had served as head of the Bank of Israel from 2005 to 2013 and ex-chief economist at the World Bank. The surprise was the timing of Fischer's announcement, his four-year term was due to expire in June 2018. It is not the norm for the vice chair to be elected for a second term, unlike the position of chair, where Volcker, Greenspan and Bernanke were all given a second chance to lead. But what it does do is gives President Trump a real chance to change the Fed; after Fischer’s departure in October, there will be four vacancies on the Fed’s seven-member Board of Governors.

In other news the world’s largest sovereign wealth fund, that of Norway which is a little under $1tn in size is to seek permission to reduce its bond holding from 23 currencies to just 3,: sterling, euro and US dollar. The letter to the Finance Ministry dated September 1st, states that ‘gains from International diversification are considerable for equities, but moderate for bonds’; this applies to the $333bn they hold in bonds. The letter went on to say, ‘For an investor with 70 percent of his investments in an internationally diversified equity portfolio, there is little reduction in risk to be obtained by also diversifying his bond investments across a large number of currencies’, adding ‘Limiting the index to dollars, euros and pounds wouldn't outlaw investments in other currencies’ and ‘we assume that the fund will continue to be invested in some of the currencies and segments that we recommend removing’. As a result, ‘deviation between the benchmark index and the portfolio will increase.’ The fund will try to limit those deviations as much as possible. The new benchmark is said to consist of: 54% US dollars, 38% euros and 8% in sterling.

Broadly, the fund is worried about the tendency of government bond markets to track each other rather closely. Such is the case in comparing Japanese bonds with Bunds which yield virtually the same, although Japanese inflation is currently at 0.4% and Germany is running at around 1.8% per annum. With the Japanese central bank committed to purchasing 80 trillion yen ($726bn) of bonds annually, the market is ‘large but far less liquid’ than for the three main currencies, the fund said. The risk is that it owns JGBs with no diversification benefit, but would struggle to sell them in the event of a market downturn.

Finally, Tajikistan, the central Asian country rated B3 by Moody’s looks likely to come to market with their first ever bond. The deal is expected at over USD 1bn for a 10-year maturity, so that it is positioned in the JP Morgan Emerging Market Bond Index making it a ‘must buy’ bond for many emerging market funds. The deal will be used to finance the construction of the world’s tallest dam and the largest hydroelectric power station in central Asia.

The bond is expected to yield about 6.25%, slightly more than the recent Belarus deal (rated one notch lower) which trades at a yield just over 6%. According to our RVM a B3 rated issue with a duration of 8.5 years should trade at a spread around +657bps over US Treasuries, thus a yield of around 8.66% per annum.  With Tajikistan’s foreign reserves standing at only $600million, less than 10% of its annual debt repayment, this issue (should it come to market) is certainly reflecting how crazy the market has become.

This is one issue we would not look to hold. What’s that old saying? ‘Only lend to those that have the ability to pay you back’.