The Weekly Update

As we start the week the market is digesting the results of the first round of the French Presidential Election which saw Emmanuel Macron and Marine Le Pen advance to the final round run-off on 7th May.  Macron is expected to win given he has now received the backing of François Fillon the Republican candidate and Benoît Hamon the Socialist candidate.  The euro has been the obvious beneficiary of the result and asset markets generally are trading with more of a risk-on bias during Monday morning trading. The 10-year OAT has rallied and the yield is trading 0.84% (at the time of writing) with the spread over bunds having tightened to ~50 bps. That said the French parliamentary elections will follow shortly in June and neither Macron or Le Pen have well established parties (in terms of number of parliamentary seats) so it remains to be seen whether the next President can win/secure support from enough seats to be able to effectively implement their policy agenda.

The ECB meeting later in the week will be a focus as investors look for signs of stimulus withdrawal from the ECB; monthly asset purchases have been cut back to €60bn from April 2017. The Eurozone April CPI flash estimate is also due on Friday which will be closely monitored: in February the reading ticked up above 2 percent although it retraced to 1.5 percent in March. The BoJ is the other central bank due to meet this week.

France, Spain, the US and UK are also due to release Q1 GDP data later in the week.  Consensus estimates expect the US economy to grow at 1.1 percent in Q1 2017 down from 2.1 percent growth in Q4. This is a big week for US corporate earnings with some of the big names such as Exxon, and Microsoft reporting. President Trump has also been on the news wires talking about some tax announcements being made but it remains to be seen if much in the way of detail is forthcoming. Hence this week is shaping up to be more eventful than last week.

The key event of the last week was Theresa May’s volte face surprising the market with a UK general election on June 8 and stating how the division in Westminster ‘risks our ability to make a success of Brexit’. This gave sterling a nice boost, until a disappointing set of retail sales numbers were announced on Friday. March retail sales ex auto fuel were particularly weak falling 1.5% mom and falling 1.4% over the first quarter which will fuel concerns about the negative impact of Brexit. The ONS noted that retail sales have made a negative contribution to economic growth for the first time since 2010. Ironically, this follows the IMF’s upward revision to its UK growth forecast earlier in the week: it forecasts that the UK economy will grow by 2% in 2017 and noted growth ‘remained solid in the UK, where spending proved resilient in the aftermath of the June 2016 referendum in favour of leaving the European Union’.

Along with the upbeat message on the UK economy the IMF also viewed the global economy with a more bullish look. Now it expects world growth to be 3.5% in 2017 and 3.6% in 2018. However they warned there may be dark clouds on the horizon. As Maurice Obstfeld, the IMF’s economic counsellor observed that ‘The global economy seems to be gaining momentum, we could be at a turning point’ but cautioned ‘even as things look up, the post–world war two system of international economic relations is under severe strain despite the aggregate benefits it has delivered – and precisely because growth and the resulting economic adjustments have too often entailed unequal rewards and costs within countries’, adding that ‘One salient threat is a turn toward protectionism, leading to trade warfare. Mainly in advanced economies, several factors – lower growth since the 2010–’11 recovery from the global financial crisis, even slower growth of median incomes, and structural labour-market disruptions – have generated political support for zero-sum policy approaches that could undermine international trading relationships, along with multilateral cooperation more generally’.

The IMF listed protectionism as one of 6 downside risks to the global economy, with others including an aggressive rolling-back of financial regulation leading to excessive risk-taking and faster than expected interest rate increases in the UK leading to financial market disruption.  However, by far the biggest concern is protectionism, with Obstfeld predicting that ‘Capitulating to those pressures would result in a self-inflicted wound, leading to higher prices for consumers and businesses, lower productivity, and therefore, lower overall real income for households’.

The Weekly Update

This week is all about inflation with the UK leading with CPI, PPI, and RPI on Tuesday plus the German ZEW report and Eurozone Industrial Production followed by US PPI and CPI and Europe wide CPI data Thursday and Friday. So focus in the West will be on comments from the Fed and European central bankers.

In Asia we have a mass of Japanese data including trade, machine orders, industrial production, M2 and the report on foreign bond flows by Japanese investors and in China money supply, trade and CPI/PPI. We also have the Reserve Bank of Australia’s financial stability review to digest.

In Latin America, Mexico’s reserves will be of interest to the currency players as well as industrial production and the central bank minutes, and in Brazil we have a Selic rate fixing with expectations of 11.25% from 12.25% and retail sales to contend with, broadly a quiet week for data globally.

After a 12 year ban on new projects, Qatar Petroleum is to start a new natural gas project in the so-called North Field, Southern section, which they expect to have capacity of 2 billion cubic feet per day, which is the equivalent of 400,000 barrels of oil a day; this should come on-stream in around five years’ time.

One of the companies that should benefit from this new production is Nakilat (Qatar Gas Transportation Company) which has the largest LNG fleet in the world, mostly owned outright, but sometimes in joint ventures, with 67 LNG tankers and 4 LPG vessels.

We have positions in two bonds issued by Nakilat both maturing in 2033 and both have a scheduled sinking structure, that is they gradually get redeemed by a scheduled amount each coupon payment date up to maturity. One of the bonds has already been sinking, since 2010, while the other is due to start in 2021. As these are both scheduled amortisations we need to look at the average life to assess value so slightly more involved, as the calculation to determine ‘fair value’ needs to build in the extra cash you receive in addition to the coupon flow prior to the maturity date. Broadly, you have an extra payment, from principal, to reinvest as well as your regular coupon and so more compounding to take into hand.

Basically, these two bonds are cheap as a number of investors and their systems do not cope very well with this structure. Both bonds are rated but one is 1st Lien and the other 2nd Lien, a difference in the rating of one credit notch Aa3 verses A1. But both according to our Relative Value Model (RVM) are around 5 credit notches cheap and offer a return and yield of close to 12.5%.

The US housing market is a $26tn asset class, larger than the US stock market. Whereas the stock market and certain property hotspots have rallied in recent years, US house prices on average have stalled for the past 3 years. Alongside the rise in overall household debts, it’s worth noting that mortgage delinquencies also spiked up dramatically at the end of 2016 after six years of steady decline (mortgage delinquencies and defaults continued to rise for a couple of years following the Global Financial Crisis). These were a leading indicator of the 2008 market crash and were trending upwards from early 2006. In the 4th quarter of 2016 US prime mortgage delinquencies jumped from 2.6% to 3.1% of loans.

Since the peak of 7.3% in early 2010 there have only been a couple of modest single-quarter spikes in delinquencies, none as large as the latest, and all reverting downwards again in the following quarter. Given that we are close to recent historical average levels (~2.5% in the decade preceding the crisis) this may just be a fluctuation and future readings will not drift that far from current levels. But given the high levels of total household debt and the expected rise in rates and potential living costs it is also possible that we will see more households struggling to make mortgage payments on-time (even if these don’t rise due to typically fixed rates).

The Weekly Update

The big number this week is of course US Non-Farm Payrolls on Friday with +175k expected for the headline number, a stable 4.7% unemployment rate, and a small increase in average hourly earnings to 0.3% from 0.2% previously which is an actual decrease in the year-on-year rate of 2.7% from 2.8%. We also have minutes from the FOMC and ECB on Wednesday and Thursday. Across the globe we have the PMI numbers with Europe starting today along with the US manufacturing number, ending with the week with China’s and India’s on Thursday. Other data includes US Durable goods and European retail sales.

In Asia we have a few holidays as China has ‘tomb sweeping’ today and Hong Kong has a day out tomorrow. Japan released their Tankan this morning which showed some improvement of small and large manufacturers, and Friday we have a mass of Asian central banks announcing their reserves.

In Latam Brazil’s inflation numbers and Industrial production could be of interest as will be México’s CPI and Leading Index but as usual their relative currency swings may be the focus for the market.

Of course the Trump / Xi meeting will be of interest Thursday and Friday and we expect more of the same from FOMC speakers as they all seem to be talking from the same hymn sheet at the moment to a lesser or slightly more aggressive degree. ECB president Draghi is also speaking in Frankfurt which will be eagerly awaited for any further clues on his tapering plans.

In our bonds we would expect relative calm until we see Friday’s NFP report although we still need to keep one eye on the US stock market. Friday will give us more insight into how the economy is ending the 1st quarter and will set the tone for the coming week or so with the market maintaining a much lower trajectory for rate increases, which we agree with, than the FED’s own ‘dot plot path’.

The Green Bond market has really taken off over the past couple years and according to Moody’s just last year the market rose 120%; boosted by Chinese issuers, particularly Chinese banks, in their fight to reduce pollution across the country. Issued with an intention to fund environmental projects, corporates, banks and supranationals have been issuing these tax-exempt bonds, which now account for over USD 200bn total issuance; although still a tiny proportion (~1.5%) of total global debt to plough into climate changing projects; if we consider the growing impetus of the Paris Agreement.

Last week the National Bank of Abu Dhabi (NBAD), Abu Dhabi’s largest lending bank and the UAE’s second largest, issued the GCC’s first ever ‘Green Bond’. Abu Dhabi holds ~6% of the world's oil reserves, and its hydrocarbon industry generates ~80% of the government's revenues and accounts for over half of the nation's GDP. The government has therefore taken steps since 2015 to diversify the economy away from the hydrocarbon complex into lending, investing and facilitating renewable energy projects ‘focused on environmentally sustainable activities’, NBAD said. According to the head of sustainable business banking at NBAD, Nathan Weatherstone, there is ‘approximately $640bn of investment required for renewable energy projects across the West-East Corridor’. The new NBAD 5-year USD 587m Green deal is just a drop in the ocean, but a step towards achieving a goal of reducing oil energy reliance.

Rated Aa3, just one notch below that of the Emirate, the 3% 2022 bond was issued at a spread of 109.10bps over Treasuries, we calculated that the expected return, if the bond were to reach fair value would be 2.2%, with a yield just under 3% and ~3 notches of spread cushion. According to sources, the deal was just under 2x oversubscribed, with Middle Eastern banks and funds accounting for ~27% of the issue; while European institutions bagged 50% of the deal. We did not enter into the deal as we have chosen not to hold GCC banks for the time being, and we feel better value lies with, for example China’s state-owned oil company CNOOC’s bonds. The CNOOC 3.8775% 2022 issue currently trades ~55 bps over what we deem is fair value for similar bonds, this implies an expected return and yield of 5.5% for the Aa3 rated issue, which is comfortably over 3 credit notches cheap.

On Wednesday last week, after 9 months of waiting, the Brexit referendum has finally given birth to Article 50. In a sign of the times, the President of the European Council Donald Tusk notified the world of his receipt of the official letter via twitter a few minutes before 12:30 GMT. Prime Minister Theresa May then addressed the House of Commons calling the occasion a ‘great turning points in Britain’s history’; meanwhile Tusk opened his address stating ‘There is no reason to pretend this is a happy day, neither in Brussels nor in London,’ and concluded with ‘we already miss you’. The letter and accompanying speech remained clear in pursuing a hard Brexit, stating ‘Because European Leaders have said many times that we cannot ‘cherry pick’ and remain members of the Single Market without accepting the four freedoms that are indivisible. We respect that position. And as accepting those freedoms is incompatible with the democratically expressed will of the British People, we will no longer be members of the Single Market.’

Anecdotally the pen used to sign the agreement was a Parker Duofold: from a US company that used to manufacture in the UK but moved production to France in 2011. One hopes this is not a portent of Brexit causing other UK businesses to go the same way. The only real unambiguous consequence of today is that it is indeed a “historic moment from which there can be no turning back”. In two years we will begin to see whether this new uphill struggle leads the UK to the new heights of “A Truly Global Britain” or straight off a precipice.

The Weekly Update

Last week the yield on the 10-year US Treasury fell 9bps to 2.41%, mostly driven by Trump’s abandonment of the health care bill vote. In fact Trump-euphoria appeared to wane ahead of the AHCA vote, as the GOP are not in favour of replacing Obamacare; as such the dollar continued its retreat, with the DXY Index falling 0.67% over the week, back below $100 level as markets have been forced to rethink their pricing.

If we look back a few months ago Trump was the engine of economic and market change, and the markets consequently priced bond yields higher along with a stronger stock market. However, as we have argued a number of times Trump will have a problem with getting his reforms passed through the house. From our viewpoint Americans have voted for change and Trump appears to be just the change, however his appointments to key positions in his administration from the corporate sector is a big mistake. We have argued that 10-year bond yields above 2.5% is a buying opportunity and the stock market is very toppy, with an optimistic bias as the market assumes Trump will be able to effect some economy positive factors. However, we doubt the political situation will permit much change as politicians can always hide behind the huge budget deficit, when in fact they are going to force Trump into a box of frustration to teach him the political club really runs the USA. As expectations for future reform continue to hang in the balance, markets will look to focus on the outcome of the upcoming  tax overhaul bill.

Elsewhere, the UK is to trigger Article 50 on Mar 29th, this week Wednesday, while the Scottish debate on a second independence referendum will take place on Tuesday. Rating agency Moody’s highlights: ‘The credit implications of Brexit are likely to remain modest and manageable for most UK issuers in our base case scenario. This implies that rating implications may be limited for most UK-domiciled issuers’. Moody’s rates the UK Aa1, with negative outlook. With CPI surprising on the upside last week, up 2.3% in February, there has been some debate on whether rate normalisation should begin, however, with the huge unknowns surrounding Brexit negotiations, monetary policy is expected to remain unchanged in the short-term.

Elsewhere, ‘serial defaulter’ Argentina issued a 3.375% 2020 new issue, rated B3 by Moody’s; initially touted at CHF300m the deal was up-scaled to CHF400m. Despite Argentina being rated 4 stars on our NFA model this is not an issue we would look to hold. We have never held debt issued by Argentina mostly due to its past default history, the fact that it is rated sub-investment grade and has negative risk-adjusted expected returns, however, we always monitor the bond market. This was an interesting issue, as there was a huge amount of market demand with recent positive developments including: Moody’s recent rating outlook upgrade to positive from stable, and JP Morgan including Argentina in its EM local indices bucket. Argentina has always been a favourite with other investors as shown by the issues in April last year when they issued $16.5bn in new bonds with interest rumoured, at the time, to be in excess of $70bn.

Unfortunately we calculate that Argentina’s debt trades expensively, with the 7.625% 2046 trading at a spread around +450bps over USTs, where similar bonds trade at around 506bps over. This suggests that the market is actually pricing in further improvement and rating this particular B2 bond one notch higher, at B1. We have never held anything expensive on our portfolio, as this prices in more chance of a capital loss, in this case, over -6%. We would much rather hold USD debt issued by United Mexican States: where the A-/BBB+ rated 4.6% 2046 issue for example has an expected return and yield of over +14% and +2.2 credit notches of protection.

Looking to the week ahead there is little in the way of economic data releases from the US until Thursday, where we will get the third reading for Q4 growth and core PCE release. Of course Article 50 will take up European focus and we expect continued central bank comments throughout the week. In Asia, Japanese retail sales and CPI are due, but of more interest will be China’s PMI release on Friday. With little data and little scheduled central bank activity the markets should be relatively calm this week, but as always, look out for the unexpected.

The Weekly Update

Last week started with rumours that the UK would formally trigger the process of leaving the EU on Tuesday. However, before Theresa May’s government could trigger Article 50 she had to finish the legislation in parliament that gives her the right to do so. Although the government was given a relatively easy ride by parliament initially, with regards to triggering the process, it has since suffered 2 defeats in the House of Lords. The amendments, on whether parliament should have a vote on the final Brexit deal and a guaranteeing of the rights of EU nationals in the UK, were debated on Monday and sent back to the House of Lords, where they accepted the supremacy of the Commons. It has since been declared that the UK is to trigger the Brexit process on March 29th.

On Wednesday we had a clear case of ‘sell the rumour, buy the fact’, when the FOMC raised the Fed's funds rate target by 25bps sparking a rally across the US Treasury (UST), stock, emerging market forex, as well as Latam, Middle East and Far East bond markets. The rate hike was followed by a much more dovish Fed statement than was previously expected. In the post announcement press conference Fed Chair Janet Yellen stated, ’It is likely that target policy rates will go up in line with their forecast. As such we don’t expect any acceleration in the pace of hikes as long as economic developments remain on track, as a result, we maintain our monetary policy outlook, expecting two more hikes this year and two more next year’.

Of course the market remained sanguine regarding these further rate hikes, and continues, as it has over the last two years, to have lower rates priced in. If we look at the medium of the Fed's ‘dot plot’ path they have indicated Fed funds rates at 2.25% by year-end and 3% at the end of 2018, much higher than the OIS (Overnight Indexed Swap) priced by the market; which implies around 1.35% at the end of this year and just 1.75% at the end of 2018. Strikes us that if the Fed does enact two more hikes this year, consistent with their current path of just 25bp per move, that puts the higher band of the Funds rate at 1.5% not 2.25% as inferred by the ‘dot plot’ medium path and so this indicator looks to be an inaccurate measure given Yellen’s statement.

As mentioned above, UST rallied across the curve sparking a global bond rally with 5-year yields 13bps lower, now trading at around 2%, and 10-years 11bps lower, now trading around 2.5%. Basically, we have been saying the market was oversold coming into the meeting as 10-year UST yields had moved up around 20bps since February month-end and at this morning’s levels we now make UST rates at fair value given the economic and political outlook for the up-and-coming Trump budget etc. Broadly, we feel there is a risk premium already built into current pricing although we still see the longer-end of the yield curve as the best value, and with the highest potential return on a risk adjusted basis.

Elsewhere, Chinese economic data releases added impetus to the country's growth momentum. February’s industrial production (IP) release beat market expectations, accelerating 6.3%yoy; boosted by manufacturing and utility sectors. Fixed asset investment (FAI) also exceeded expectations coming in at 8.9%yoy, from 8.1%yoy in January. Meanwhile, retail sales fell short of the market consensus (although still stood at 9.5%yoy) driven by a fall in auto sales; this was possibly due to overbuying of cars in 2016 ahead of the reduction in tax incentives on low-emission cars this year.

The property sector, which has been somewhat of a concern, has also shown signs of moderate recovery with property investment gaining 2% to 8.9%yoy. According to China’s National Bureau of Statistics, third- and fourth-tier cities have benefited from the recent increase in property sales which is in-line with policymakers’ push to reduce inventory in the lower-tier cities: part of the five economic tasks of 2017.

Earlier this month at the National People's Congress (NPC) it was announced that China’s growth target was officially lowered to 6.5% (from 6.5-7%). With the recent bout of positive data prints, and all else being equal, we do not expect the economy will struggle to achieve this level of growth, and could in fact exceed it. However, the government would not want the economy to overheat, nor push for growth just so that a target can be achieved, rather continue on its path of more quality and sustainable growth while identifying and managing financial risks.

No doubt the growth rate will determine the monetary and fiscal policy mix. We expect policymakers to maintain a bias towards proactive fiscal policy, especially as monetary policy is constrained as the PBoC looks to stem capital outflows. The lowly 3% budget deficit as a percentage of GDP this year gives the government sufficient room to deploy all number of quasi-fiscal measures to maintain growth targets: if for example inflation spikes and the central bank has to tighten.

The Weekly Update

Fridays February non-farm payroll release showed 235,000 jobs added which was above expectations of 200,000 jobs created and the prior month’s reading was revised up by 11,000 jobs to 238,000.  The construction sector, helped by the mild winter weather, saw strong job gains of 58,000, the largest gain since March 2007; while the manufacturing sector saw robust gains at 28,000 jobs, the most since August 2013.  The unemployment rate edged lower to 4.7% from January’s reading of 4.8% although the participation rate edged higher to 63 percent as more people entering the workforce found jobs.  Average hourly earnings grew 2.8% yoy which was in line with expectations and the upwardly revised January figure of 2.8% yoy (from 2.5% yoy).

The market is now fully discounting a 25 basis point hike in the Fed Funds rate in March and further rate rises thereafter. US Treasuries closed with little change on the back of the figures.  The key point is that the inflation backdrop remains benign and the Fed is moving ahead of the curve.  Thus, our view remains that the yield curve will flatten and we favour positioning at the long end of the yield curve.  If the US economic data points remain strong then it is likely that there could be an additional two 25 basis point hikes as the year progresses.  Our proprietary models suggest that the 10-year US Treasury yield above 2.5% is already discounting this.

In terms of positioning, we look to target the long end on a duration weighted basis and have been looking to manage our position by selling outperformers in the belly of the curve.  Although Europe has creditor nations the lack of value on our models makes this an easy risk to avoid.  While spreads in investment grade credit may not tighten significantly from current levels we still see opportunities from targeting undervalued credits with several notches of credit cushioning versus their rating and which trade on attractive positive yields.

In other news last weekend the Chinese Premier Li Keqiang acknowledged the government’s efforts to steer the world’s second largest economy to a ‘new normal’ of slower but better quality growth, that is more geared towards domestic consumption and less debt dependant. Such a transition is not an easy one; as Mr Li put it ‘Like the struggle from chrysalis to butterfly, this process of transformation and upgrading is filled with promise but also accompanied by great pain’.

Mr Li was speaking at the start of the National People’s Congress where he also said that the annual economic growth target for 2017 would be around 6.5%. Last year at the same conference the target for growth was put at between 6.5 and 7%; actual growth came in at 6.7%. The Chinese government are willing to sacrifice a small percentage of growth in exchange for paying more attention to financial and economic risks in the coming months and years. ‘Financial supervisors should fix weak links and act hard against illegal activities’ he said whilst believing that there is a need to rein in house prices, as houses are to be lived in, not for speculation, referring to the recent big increases.

Closer to home and as expected, Philip Hammond’s first and last Summer Budget delivered numerous but all modest adjustments to overall government spending. This has been reflected in markets with both sterling and Gilts little changed from before his speech. Beyond the peppered insults towards the leader of the opposition, the most notable mentions were the changes to the OBR’s forecasts.

An estimated £24bn less public sector net borrowing over the current and next 5 years, from more resilient growth and tax receipts, will support the Chancellor’s vision for ‘Getting Briton back to living within its means’. The overall growth forecast over the next 5 years remains little changed, but the trajectory places more of that growth in the current year (2%, up from 1.4% previously) whilst reducing subsequent years’ growth by 0.1%, 0.4% and 0.2% for 2018, 2019 and 2020 respectively.

Attempts to equate the taxation between the employed and self-employed was probably the most significant revenue bolstering announcement, alongside commitments to ‘tackle avoidance, evasion and noncompliance’. Other notable initiatives include the introduction of T-Levels, new technical qualifications; funding for 110 new free schools; counterbalancing measures for the forthcoming increase in small business rates and an overall drive to boost productivity. However, with the vast number of restrictions and protected spending across almost every department, and the Conservative’s election manifesto promising no income, value added or NIC tax increases, these bean-counting adjustments are about as much as could be expected from a Chancellor with his hands tied.

The Weekly Update

At the beginning of last week the market had priced in just a 40% chance of a March rate move. What a difference one week makes, as that level is now around 90% following some hawkish comments from Fed officials. San Francisco Fed President Williams said that a March hike is getting “serious consideration” given that the Fed is “very close” to achieving its dual mandate goals. Later and in an interview with CNN, NY Fed President Dudley said that the case for tightening had become “a lot more compelling in recent months” and that “risks to the outlook are now starting to tilt to the upside”. Finally, Fed Chair Yellen said that “at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate”. She also added that “given how close we are to meeting our statutory goals, and in the absence of new developments that might materially worsen the economic outlook, the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016”.

During the week, President Trump delivered his first speech to Congress. In what was a much more crafted and rousing speech than we have become recently accustomed to, he sought to garner further support for his policies which include (in approximate order of planned implementation): repealing Obamacare, tax reform, deregulation and infrastructure investment. Of course, he hopes the 'Great Great Wall' of America can jump the queue to help speedily address the drug and perceived immigration issues that are threatening the safety and wellbeing of American families and workers. Though with the wall estimated to cost somewhere between $10-20bn it's hard to accept the plan's cost efficiency and efficacy for addressing these problems (given that, for example, 40% of Mexican immigrants come via airplanes, and the strong consensus that a wall would do little to stem the inflow of drugs).

This order of policy priority is more of a necessity than a preference for the Administration. For they will need to make good ground addressing costly healthcare reform before fully pushing for tax reforms that both benefit middle-class and have a chance of passing the House and Senate. Delivering on these will then make it easier to successfully secure additional spending on infrastructure.

But as always the devil is in the detail, and as radical as the new White House is, they need sufficient backing from the Hill. Executive orders only go so far, and as we have seen can be repealed. Even with the number of seats the Republicans have, it is still proving difficult to find a compromise on disliked Obamacare, let alone the other policy initiatives. Congress is already at a crawl due to divisions amongst Republicans on the issue. Although some existing aspects have strong support, such as providing for those with pre-existing conditions; and some new aspects have unified backing, like 'freedom to purchase health-insurance across state lines' which received a hearty applause from Republicans; there are numerous aspects on which administration cannot find a consensus. Healthcare tax credits is one example which Trump advocated for in his speech, but which Conservatives are strongly against. Finding sufficient common ground is clearly going to take much longer than many expected.

Hillary Clinton previously had a rebuking campaign slogan to 'Build bridges, not walls', but it seems in some way Trump is trying to build both. In the speech Trump told of how 'America is willing to find new friends and forge new partnerships, where shared interests combine.' Moreover, domestically Trump called again and again for a unified bipartisan front stating, 'We must build bridges of cooperation and trust, not drive the wedge of disunity'.

But behind all this vision for a 'Renewal of the American Spirit' (the title of his speech) there continues to remain a lack of detail in the vision: something markets and the American people are becoming increasingly anxious for as the days roll into months. Given that 'The stock market has gained almost $3 trillion in value since the election on November 8, a record.' if this lack of specificity continues there is concern that these valuations, based mostly on optimistic short-term growth expectations, will revert to concerns over lower long-term growth: which has changed little or likely worsened since Trump was elected.

The Weekly Update

True to recent form, politics continued to command a dominant position throughout the week as the French presidential election is shaping up to be a bit of an odyssey, and it is yet to even get to the first round of voting. Let’s not forget the UK’s ongoing attempt to extricate itself from Europe, along with elections also due in the Netherlands (March) and Germany (September) and discussions over Greece’s terms and size from international lenders for the third installment of emergency loans. Not forgetting Mr. Trump’s recent victory, 2017 is certainly panning out to be a very interesting year!

One country that has certainly benefited from a more benign focus (at least from a bond market perspective) is Russia, where the 5-year CDS has rallied from the extremes of 607 basis points (bps) in 2015 to today’s level of 171. Pre Crimea (but post the 2008 crisis), the spread had touched 120 bps at its tights.

Indeed, recently Moody's Investor Services raised Russia’s outlook to stable from negative adding Russia’s strategy ‘reflects an ambitious fiscal consolidation strategy incorporating conservative spending and revenue assumptions’. Russia’s Economy Minister Maxim Oreshkin, said there are ‘objective grounds’ for a ratings upgrade.

Moody’s cited an improvement in the economy as well as a fiscal consolidation strategy that should help wean the country off its dependence on oil. That means that all three major agencies have now confirmed the economy is stabilising after almost a two year long recession, the longest in almost two decades. The Economy Ministry expects growth to reach 2% in 2017 while its 4% inflation target is also within reach, currently at 4.7%. Steady oil prices, the Russian budget has $40 per barrel built into it, improving mining, agriculture and manufacturing data all are contributing to the improved outlook.

This news has benefited our Russian holdings although there is no sign as yet of an upgrade with Standard and Poor’s and Moody’s retaining their non-investment grade rating; with Fitch the only one of the three that held their BBB- investment grading during Russia’s economic and political problems. By way of an example our holding of Gazprom 8.625% maturing in April 2034, a USD denominated issue, is now priced around 130.75 which is a spread of 311 bps off of the US Treasury curve. If we utilise the Fitch rating, the better of the three agencies, this equates to a price which makes the bond 2.4 credit notches cheap to our fair value spread of 203 bps and offers us a return plus yield of 15.7%. Should this bond trade into its fair value spread it would rally around 15 points in price terms.

The Weekly Update

Last week Federal Reserve Chair Janet Yellen delivered her semi-annual testimony to the House Financial Services Committee, sending the Dow and S&P to new all-time-highs, and provided a boost to global equity markets.

Markets seem to have focused on her reference to the recent improving economic data - drawing a consensus that a June (or even the possibility of March) rate rise may be on the table. However Yellen also stressed caution over the uncertain economic picture; notably the risks and ‘considerable uncertainty’ associated with the current administration’s plan to boost growth through further unsustainable fiscal stimulus. In contrast she stressed ‘the importance of improving the pace of longer-run economic growth’.

Little mention was made of the Fed’s agenda for eventually curtailing its QE reinvestment policy - which markets have been fixated on. However, given assurances that whenever this is initiated it will be done gradually and the significant proportion of the Fed’s balance sheet being in long maturity mortgage and Treasury bonds some argue, including Stephen Williamson Vice-President of the St. Louis Fed, that such a step towards policy normalisation would not be as harmful or contractionary as many expect.

There is still a worry that the 1950-1981 period, when Treasury yield surged from 2% to 15%, is a relevant parallel to now. However, the contrasts could not be starker. Indeed taking the past three centuries of UK and US yields it is the past 5 decades that are the aberration; for the other two and a half centuries - when economic and demographic growth prospects were much higher than today – yields were typically in-line with current levels rather than the blow out from the 50s and 60s which included 2 oil shocks and the Fed dragging their feet for 15 years before properly adjusting policy amongst many other things.

From a longer term perspective (both historical and future) of the US economy, current comments and decisions by the Fed are likely driven by the importance of being perceived as ahead of the curve, rather than the first steps towards surging yields and accelerating growth. Given that markets have consistently overestimated the pace of Fed Funds hikes in recent years and the scant tangible improvement in longer term economic growth prospects (perhaps even the opposite) it is possible that not only is much of the Fed policy path already priced in for Treasury and bond markets, but also that the short-term bullish sentiment (bearish for bonds) and reflective equity index highs will not last the test of time. With no significant surge in potential global growth and little achievement in global deleveraging we continue to favour high quality creditor bonds that offer above average yields and attractive risk adjusted returns.

In the credit markets, there have been a number of interesting corporate issues out of late, some of which have looked relatively attractive, while others have not offered enough in terms of spread cushion. The offering from Kuwait Projects (KIPCO) is a perfect example. Rated BBB- (one notch above junk) the 10-year issue, was launched at a yield of 4.75%; which would normally be a welcome holding in most portfolios. However, using our proprietary Relative Value Model, we calculate the expected return stands at a mere 2.6%; as it trades only 32bps wider than similar securities. Although we have been long term holders of the major investment holding company in the past, and the Kuwaiti ruling family indirectly owned a large stake in the company, this issue offers very little in terms of cushion, with less than one notch of credit protection.

Ahli Bank Qatar, another corporate new issue to the market priced at +163bps over UST, which is relatively attractive given similarly rated A2 bonds with a duration around 4.5 years trade at ~91bps. The expected return and yield is calculated at 6.6%, with 3.3 notches protection. Although this bond offers far more spread cushion than the KIPCO issue and a higher credit rating, we would not look to hold it as we have chosen to not hold GCC banks at the moment, and Ahli Bank is tiny at~3% market.

As regular readers will be aware, just as we are constantly looking to make attractive risk adjusted investments we are equally keen to avoid taking any unnecessary risks when building our portfolios by undertaking sufficient credit analysis and evading the ‘search for yield’ trap where downside “cushion” may not adequately compensate for when things don’t go quite to plan.

The Weekly Update

Last week Greek 2 year bonds touched yields of 9.5% on the back of a disenchanting report from the IMF which has revived a dispute between the IMF and EU creditors. Europe and markets generally have continued to assume that the IMF would eventually join the third bailout programme for Greece which for the last three years has fallen solely to the European Stability Mechanism (ESM). The IMF was meant to have decided on their participation by end 2016 but continue to abstain whilst arguing for a 1.5% primary surplus – rather than an “unrealistic” 3.5% target by 2018 as demanded by the European Commission – which would necessitate significant debt relief from other Eurozone countries.

With €7bn of debt due in just 5 months another bailout will need to be reached before then and this latest spat clearly makes this more difficult; bear in mind just how little consensus has been reached in the past 2 years of negotiations. German officials have warned that without the IMF the entire rescue programme would be axed. With government debts already at 180% of GDP the IMF forecast that this debt load would turn “explosive” after 2022.

Those disputing IMF’s concerns say they have yet to fully factor the most recent improvements in the Greek economy which have been notable on the back of increased tax revenue and expectations that the economy will grow above 2% this year for the first time in a decade; that is of course after real output dropping by over a quarter since the crisis and having ebbed at this nadir for past 2 years. Greece is of course already 8 years on, so many hope it is about time for some recovery. But just because its economy has stopped shrinking does not give proper cause to believe it is assured a long term trend of growth. There are few promising opportunities on the horizon for Greece in the face of unemployment, depressed domestic spending, global secular stagnation and little in terms of policy in the pipeline that would be a boost.

One of the issues again being discussed is the risk of redenomination of Greek debts is the case of a Grexit and reinstated drachma. This of course would no longer be the preferred option for Greece itself (perhaps regaining monetary sovereignty in order to inflate debts away would have been the best option back in 2010 but that opportunity was missed). As numerous as the concerns are for Greece this is perhaps less of a concern for Greek international debt which mostly follows English law. So if the European Project does fall apart at least those holding Greek debt would get whatever funds they can recover back in euros. We of course remain averse to almost all European government debt either for lack of value or excessive and under-priced risk. A decade ago when Greece was still A1 rated and could borrow at 1% for 2 year and 4% for 10 year debt we were warning of their excessive Net Foreign Debts. Following adoption of the euro Greek debts ballooned – lured by markets wrongly associating the various euro denominated government debts.

We prefer to hold a positions such as the US company, Southern Copper Corporation across our global bond fund products. Headquartered in Phoenix Arizona with mining activity predominantly undertaken in Peru and Chile the US dollar denominated 7.5% 2035 issue has performed extremely well and is one of the few bonds currently trading above the Trump election sell-off back in early November. This bond has rallied nine points since the election and continues to offer attractive risk-adjusted value. Currently trading at a spread of around 300bps off of US Treasuries, this BBB/BBB+ rated bond remains about 4.3 credit notches cheap against its RVM fair value spread of 145bps and equates to an expected return and yield of 22.3% should it move to fair value. Of course the 5.6% yield is a welcome addition to any portfolio.

We continually search for rotation candidates across our portfolios as some names move faster than others, or indeed individual companies/Government issuers are affected by their own characteristics such as further supply or news affecting profits. However, it is challenging to find a candidate to rotate into from our Southern Copper holding which still offers so much on a risk/reward basis currently.

The Weekly Update

Friday’s January non-farm payroll release showed 227,000 jobs added which was above expectations, although the unemployment rate edged higher to 4.8% from December’s reading of 4.7%. Importantly, average hourly earnings grew 2.5% yoy, down from the previous month’s figure of 2.9% yoy, and below expectations of 2.8% yoy.

The Fed’s December projection is for 3 hikes in 2017 and 2 in 2018 but considerable uncertainty remains in terms of how much tightening will be required given a lack of policy detail from the Trump Administration. The January Fed meeting statement made no policy change with a somewhat dovish stance emphasising a gradual data dependent approach to tightening. Given the asymmetric risks that tightening too aggressively brings, and a lack of policy detail from the Trump administration, it comes as little surprise the Fed is exerting some caution. Thus, the Fed futures are discounting a 69.5% probability of a hike at the June meeting.

The US economy grew 1.9% in 2016 based on the latest Q4 data keeping the economy set in the ~2% trend that has been the case since 2010. So far, we see little evidence to convince us that growth can sustainably be boosted back above the 3% level as the structural trends of poor demographics, secular stagnation and elevated global debt levels remain firmly entrenched. It will be interesting to see how the US debt ceiling negotiations progress in March as an indication of scope for a more expansionary fiscal policy. Even if there is a boost from Trump’s stimulus and tax cuts that is not more than offset by a more protectionist trade policy the effects are unlikely to impact until 2018. A stronger dollar would remain a drag on both growth and inflation.

We expect that the Fed will remain ahead of the curve in the process to normalise rates and the yield curve is likely to flatten. US Treasuries have already factored in a significant amount of policy tightening with the 10 year yield having backed up 110 basis points from the July 2016 low of 1.36% to ~2.46%. Against such an uncertain global backdrop a portfolio of high quality bonds from creditors, particularly those offering positive yields, remains one of the most attractive places to be positioned.

One thing you can say about Trump is, unlike many politicians globally, he has followed through with some of his main campaign promises, albeit some more recent actions deemed controversial by many. We suspect the broadly dovish Fed members will act on a wait-and-see basis, as there has been little to no guidance from the Trump administration with respect to fiscal policy deployment and the consequent effects on US growth.

Our base case is that the dollar remains strong, boosted by higher growth expectations and carry traders attracted by higher US short rates. However, with Trump adopting controversial policies (read ‘muslim ban’), this may damage the allure of the US dollar as a reserve currency. Valiollah Seif, the governor of the Central Bank of Iran last week stated that preparations are underway to ditch the dollar ‘as its currency of choice in its financial and foreign exchange reports’, effective March 21. At this stage the alternative is unclear, although Seif did discuss the option of ‘selecting a basket of currencies or choosing the currency that plays the biggest part in foreign trade’; this suggests the euro could play a major role.

But how about the renminbi…? Iran’s top export destination is China, at ~USD 25bn, compared with its next biggest, India at USD 10.3bn. Back in 2012, China started buying crude from Iran using renminbi, and Iran in turn used the revenue to access Chinese goods and services; so not a completely leftfield proposition. Whatever the government decides, March 21 is less than 7 weeks away, so revenues of ~41bn of the country's largest and most vital export, oil, are likely to come under pressure. We do not and have never invested in Iran.

As President Trump continues to settle into the role, with confusion and sackings domestically, one of the international situations which we still have no information on is the policy regarding the Russian sanctions. Trump has spoken to President Putin but according to reports the sanctions were not discussed.

It strikes us that it would not be in Mr. Putin’s best interests to rush to have sanctions lifted as this would cause a further rally in the rouble; which has been a key weapon in Russia’s armoury to survive the fall in the price of crude over the last few years. Indeed between June 2014 and its peak in January 2016 the rouble fell 141% against the US dollar moving from a price of around 34 USD/RUB to 82. This is somewhat in line with the fall in crude as measured by Brent which fell from a price of $112 per barrel (pb) to $28.55pb, 75%, over the same period. Since January 2016 oil has recovered somewhat, now trading at around $55pb and the rouble has also rallied 27% to trade around 60 USD/RUB.

The big devaluation in the rouble, although not popular domestically as it pushed inflation up, was essential and a well-managed policy to cope with the loss of oil income. Broadly, with Russian production costs, wages etc. all in roubles the fall in oil was offset within the Russian balance sheet by the currency weakness. This policy worked extremely well and just a few weeks ago the Russian Central Bank announced they would once again be building up foreign reserves by buying around $1bn in currencies per month. This is due to the Finance Ministry estimating that it will receive about RUB1tn ($16.7bn) in additional revenue this year with oil averaging $50pb.

Key to this of course is the value of the rouble; a strong currency could derail the process of recovery for Russia. Central to the central bank’s battle to manage the value of the rouble is Elvira Nabiullina, the bank’s governor since 2013. Nabiullina has orchestrated policy over the last few difficult years and has worked within Mr Putin’s government since he came to power in 2000, back then she was a deputy economy minister before becoming minister in 2007 and a key member of the Putin government.

As regular readers will know we still hold Russian quasi-sovereign debt in our portfolios, in hard currencies (currently USD and GBP) and have always looked at Russia as a viable investment opportunity due to the strong balance sheet of the country; with a four star rating under our Net Foreign Asset scoring system. From our point of view an easing in sanctions would likely be followed by upgrades from Standard and Poor’s and Moody’s who have Russia as sub-investment grade and would benefit our holdings almost immediately. However, if Ms Nabiullina and her colleagues at the CBR continue to add foreign reserves by managing the rouble's value, we feel the agencies will be forced at some time to reappraise Russia’s situation, even with a continuation of sanctions.

The Weekly Update

Last week, President Trump withdrew the US from the Trans-Pacific Partnership (TPP) which had taken the Obama government two years to negotiate. The TPP included 11 other nations in a free trade agreement linking countries that account for approximately 40% of global GDP. Trump, during his campaign, claimed the current TPP and NAFTA agreements were unfair to American industry, adding that workers appear to have opened the door for China to take a major role in trade within the region.

Senator John McCain of Arizona said the US withdrawal ‘will create an opening for China to rewrite the economic rules of the road at the expense of American workers’. Next month in Japan the trade deal being promoted by China, The Regional Comprehensive Economic Partnership (RCEP) which includes 16 nations has its next round of talks and includes Japan, South Korea, Australia, New Zealand and India.

Former US trade representative for China affairs said ‘It’s a giant gift to the Chinese because they can now pitch themselves as the driver of trade liberalization.’ Chinese President Xi Jinping has already started to position China to take advantage and had anticipated Trump’s move on trade. Just last week in Davos at the World Economic Forum he described trade protectionism as ‘locking oneself in a dark room’. Xi has made trade a cornerstone of his presidency endeavouring to expand trade ties with neighbours and has put in place a massive infrastructure project opening up old trading routes to the Middle East and Europe. In fact the first direct train from China to the UK arrived in London last week, re-opening the old (2,000 year old) Silk Road route; which was previously used to carry goods between Asia and Europe. After a 7,500 mile, 18-day journey the Chinese freight train delivered  ~GBP 4m worth of clothing and other goods to Barking, East London.

Not only does it look as if China will benefit from the US withdrawal from the TPP, China will also benefit from the long awaited inclusion of China in the major bond indices. Bloomberg/ Barclays Fixed Income Indices last week announced new parallel global indices that include China RMB denominated securities.

Take two influential indices: MSCI Emerging Market Index in stocks and the Bloomberg Barclays Global Aggregate Bond Index for bonds, each comprising nearly 25 countries. Both are typical to the universe of indices and as such are systematically underweight in China. For although China dominates the EM space (with the second largest stock and third largest bond market in the world) its capital mobility restrictions, quotas and transparency hinder it from being included on a level proportional to its economic significance.

As we have previously compared: ‘China‘s GDP is over 7x larger than South Korea’s which currently accounts for over 15% of the MSCI EM Index’. Currently at 26.8% China’s weighting in the MSCI EM index could rise to 27.8% with a partial inclusion which was postponed last June. This may still be on the cards for this year but China’s recent increase in capital controls make it less likely. Further into the future it has the potential to reach over 40% will full inclusion of China A-Shares (alongside already included China and China overseas shares) should the quota systems and capital mobility restrictions ever be fully abolished. With around $1.5tn benchmarked to the MSCI EM Index and plenty more active and passive money influenced by this and similar indices this transitional trend could bump up international investment to both China’s stock and bond markets.

But whereas equity investors will have to wait a few more months for the MSCI decision, the Bloomberg Barclays Indices (which have become increasingly popular since acquired by Bloomberg in December 2015) have decided to create a parallel ‘Global Aggregate Index + China’ which would include onshore Chinese government bonds whilst keeping their Global Aggregate Index unchanged. This allows investors to decide to follow either or both going forward.

Such ‘transition indices’ should be seen as a positive step for the Chinese government who continue to suggest further key reforms are imminent. It also represents an opportunity for international investors who currently only hold around 2% of both the mainland stock market and onshore interbank bond market according to the Financial Times. Should other major index providers follow suit (JP Morgan, MSCI and Citigroup expected to make announcements in the next few months) investors should consider their allocation to China in general and make the necessary adjustments before passive investments are forced to follow any potential index adjustment. Even if China doesn’t make the cut this year its disproportional economic magnitude suggests that Chinese stocks, bonds and currency should eventually but inevitably constitute a greater proportion of international portfolios.

The Weekly Update

UK PM Theresa May’s Brexit speech and Donald Trump’s inauguration were the main features last week although China grabbed some attention, with 2016 growth releases surprising on the upside.

The week started with Donald Trump stating he will look to offer the UK a fair trade deal once he is officially in office. Although the UK is unable to sign up to any trade deals until it is formally out of the EU, it can look to get the paperwork in place. Theresa May will be meeting with Trump and his advisors this week to further discuss US-UK trade deals; where it is expected that tariffs cuts are due to be discussed and the doors open on either border for ‘free movement’.

Markets braced themselves on Tuesday morning ahead of what was so far the most important speech of UK PM Theresa May’s career, where she shed some light on the the highly anticipated Brexit strategy. The main takeaway from May’s speech is: the UK is to leave the single market, but Britain would seek an ‘associate membership’ of the customs union and ’a new equal partnership -- between an independent, self-governing, global Britain and our friends and allies in the EU’. On immigration, May stated control over Britain’s borders was a priority, adding that the nation will continue to welcome ‘the brightest and best to study and work in Britain’, however there will be control over numbers from the EU. It is still too early to tell how the UK economy will be affected by a ‘clean Brexit’ as negotiations will commence once the Parliamentary vote is cast. The IMF upgraded the UK’s economic growth forecasts to 1.5% for 2017, pencilling in a downgrade to 2018 growth expectations to 1.4%; the caveat of possible trade barriers and other unknown Brexit effects could see these forecasts revised somewhat however.

Elsewhere, on Tuesday, for the first time ever a Chinese president took centre stage at the World Economic Forum in Davos. This gathering was starkly different from previous summits, as the two biggest events of 2017 (so far), i.e. Brexit and the incoming of the possibly less trade-friendly US administration, are against everything that Davos - the global problem-solving think-tank - stands for. High up on Xi Jinping’s agenda was economic globalisation and free trade. Xi Jinping also echoed what Chinese policy makers have reiterated time and time again, that it is not their wish to devalue the renminbi to make exports more competitive. But their intention is to manage the redback against the recently expanded CFETS currency basket; of which the dollar is a large component. Non-manufacturing activities make up over half China’s GDP, so why, after all the country has done to reform its economy to more sustainable, consumer-led growth, would it wish for a weak currency; a rhetorical question. The offshore renminbi is  2.43% higher against the dollar and over 2.14% versus sterling so far this year.

A data heavy week confirmed economic stabilisation in China. The Q4’16 GDP release surprised on the upside, at 6.8%yoy, while 2016 GDP was 6.7%; comfortably within the official target. Meanwhile December’s industrial production reading was in-line with expectations, while retail sales beat consensus calls for 10.4%, at 10.9%. We expect policymakers will continue to aim for growth ‘around 6.5%’ for 2017, they have become increasingly aware of better quality and sustainable growth; with a higher tolerance to slower growth. Expectations are that they remain proactive in terms of fiscal expansion, however monetary support could be tightened as the country looks to contain financial risk.

The Weekly Update

A better week across credit markets saw the yield on the 10-year US Treasury fall a couple basis points to 2.397%. Hard/soft Brexit chatter continued to dominate headlines which saw sterling fall a further 0.85% whilst the FTSE 100 Index climbed to new all-time highs by the end of the week. Donald Trump and his relentless Tweeting also grabbed some attention, and markets appeared taken aback after his press conference on Wednesday; where there was very little clarity on future policy.

Meanwhile, Steven Mnuchin, Mr Trump's choice for US Treasury secretary is looking to achieve US GDP between 3% and 4% over the coming period, a big change from the around 2% per annum we have seen since 2009, of course we await details of how this will be achieved. We do have Mr Trump’s election promises of infrastructure spending, tax cuts and incentives for American companies to bring offshore funds back home. However, we also expect trade friction and of course immigration issues, which may result in tighter policies on entering the US, and of course a number of undocumented residents being ejected. The difficulty is, in order to achieve this level of growth there needs to be a huge rise in productivity and indeed a big jump in the US workforce, without these elements GDP cannot accelerate. On the surface the immigration policy appears to be in the opposite direction of what the economy requires.

Indeed US demographics are not very good. As mentioned the economy has grown about 2% a year since 2009 while the population has only grown by 0.76% per year, down from 0.93% in the decade to 2008 and the situation is on a downward sloping trend. So productivity challenges since the end of the global financial crisis have been hit by the headwind of demographics moving in the opposite direction. The US will also see fewer domestic consumers buying goods, which equates to less price pressure, leading to a decline in investment in aging plants and equipment - ultimately witnessing falling productivity; the opposite of Mr Mnuchin’s forecast.

Another big story last week, was the Central Bank of the Republic of Turkey’s supposed ‘intervention’ in stemming the lira’s collapse.  Despite the lira plummeting over 5.3% so far this year to new lows against the dollar (in addition to the 17.2% collapse last year), the ‘behind-the-curve’ central bank has yet to intervene on a meaningful scale, most probably out of fear. The CBT last week highlighted its concerns over the lira’s slide, and added ~USD 1.5bn of FX liquidity, and cut reserve requirement ratios across the board by 50bps. The central bank’s willingness to act against the fx mismatch saw the currency briefly fall from record highs, but we are not sure this ‘small token’ will be enough to stem further deprecation. A more substantial policy response is required via a rate hike or through further intervention, although reserves are quickly depleting.

Turkey's long-term rating was downgraded to junk in 2016 by both Moody’s and S&P last year, while Fitch maintained its investment grade BBB- rating, with a negative outlook. Having been classed an EM gem since before the financial crisis, investors appear to be falling out of bed with Turkey; a country which we have never been keen to invest in, mostly due to it’s low 2 star net foreign asset ranking, but also because we had previously seen very little relative value in the country. We would rather invest in similarly rated Russian holdings, where we view the fundamentals as being much stronger. State-owned Pemex 6.625% 2035, is also a compelling holding, offering just under 6 credit notches of protection against unforeseen events, while Turkey quasi-sovereign issues, on average, trade only 3-4 notches cheap, with a high likelihood of further downgrades.

The Weekly Update

With Trump likely to boost government spending, there will be even more attention than usual on the strength of the US economy. Despite the recent optimism, the reality is that real GDP in major economies has been declining steadily over the past 40 years, with ageing populations being a major factor. Friday’s December non-farm payroll release showed 156,000 jobs added which compares to 271,000 for the same month of 2015 and 292,000 the year before. The lower-than-expected reading was sufficient to nudge the unemployment rate higher to 4.7% from November’s reading of 4.6% and the participation rate was unchanged at 62.7%. Even if Trump’s policies do succeed in boosting growth in the short run, which seems quite likely, the underlying backdrop of ageing populations in the major economies will prove to be a significant headwind.

The other thing to watch will be global trade. Whether the actual impact of a Trump Presidency on global trade will turn out to be as negative as the campaign’s protectionist rhetoric remains unclear save that even under a better case scenario Trump is clearly looking to renegotiate the status quo. While NAFTA (with Canada and Mexico) is one agreement that he has been particularly vitriolic about, describing it as ‘probably the worst trade deal ever agreed to’, any country running a large bilateral surplus with the US could well find themselves in the firing line.

The US Treasury already releases a Semi-Annual Report to Congress on the Foreign Exchange Policies of Major Trading Partners of the US as part of a view of the exchange rate and externally-oriented policies of its major trading partners. In the October report Germany, China, Japan, Korea, Taiwan and Switzerland are all on a monitoring list having at least 2 of the following 3 traits: a material bilateral trade surplus with the US, a material current account or exhibiting persistent one sided foreign-exchange intervention. That said, under that review period none of the named countries exhibited all 3 traits or were considered currency manipulators. Nevertheless, this list of countries may find themselves more heavily scrutinised under a Trump administration.

China’s trading relationship with the US seems an obvious target with the Trump campaign voicing concern about currency manipulation. China’s decision to broaden the basket of currencies in its trade weighted index at the tail end of last year, from 13 to 24 currencies, means that the basket is now more representative of China’s trading partners as the previous basket excluded South Korea, which is China’s 4th largest trading partner. Although the timing of this move is probably unrelated to Trump’s victory, the stability or otherwise of the renminbi against the basket will be closely watched and provides a much better measure of whether the currency is being allowed to depreciate. In fact, since the middle of last year the renminbi has been broadly stable to stronger against the basket.

Nevertheless, holders of renminbi did lose 2.23% last year if they measured their performance in US dollars, although holders of euros would have lost 3.85% and sterling holders would have lost 16.3%. Whether you would have been better off holding renminbi last year depends on your starting position and 2017 will be no different.

The Weekly Update

Happy New Year to everyone and let’s hope 2017 is a prosperous year for everyone.

December was a very busy month for us with the launch of two new UCITS funds; the Stratton Street NFA Global Bond Fund launched on 30th November and the Stratton Street Next Generation Global Bond Fund launched on 16th December. With our Renminbi Bond Fund strategy, we now have three Luxembourg UCITS vehicles to complement our Guernsey PCC funds.

Looking forward, 2017 is going to be an interesting year. Against a backdrop of ageing populations in the “developed world”, voters are likely to continue to hope for a return to “the old days” even though there is very little prospect of that happening. Consequently, political change in the major economies is likely to continue with populist parties getting an increasingly large share of the votes. But whatever party is in power, one cannot escape the reality that economies cannot gain competitiveness by continuing to do things the same way things have always been done. There are plenty of difficult ways to gain competitiveness; through significant investment or by slashing wages, but the easiest one is to devalue your currency.

Which raises the question as whether Trump’s fiscal policies will achieve their goals. The short term impact is likely to be an increase in the budget and current account deficits and with the FOMC likely to tighten more quickly than might have otherwise been the case, the dollar is quite likely to rally further. But that is unlikely to make the US more competitive, quite the reverse. So don’t be at all surprised to see the US Treasury market flatten as investors look through the short term growth boost and start to factor in the combination of a stronger dollar and higher short rates on the longer term outlook for the US economy.

Which is why, after coming up with the Next Generation Global Bond Fund a couple of years ago, we were so keen to launch the fund at the end of last year. The flip side of a stronger dollar will be weaker exchange rates elsewhere. Somewhat perversely, Trump’s policies will help some of the emerging economies as they gain competitiveness if the dollar does indeed strengthen as we currently expect. Weakening currencies are bad news for indebted nations however, as their unhedged dollar liabilities rise as a proportion of GDP, but for the creditor nations, this will help their longer term prospects. In due course it will also present opportunities in some emerging currencies, although that may be a story for later in 2017 or maybe even into 2018. We shall see.

Markets are certainly interesting and anomalies remain numerous but for the time being at least, we still have a bias towards long-dated high grade bonds of the creditor nations.

The Weekly Update

This is the last weekly of 2016, so we wish you well for the holidays and look forward to catching up with you again 2017.

2017 is going to be an interesting year with plenty of things to think about. Trump’s fiscal policies are the obvious talking point as is the strength of the dollar. But is the US economy strong enough to handle two or three rates hikes? Will the housing market start to stall now that mortgage costs have risen significantly in recent months? What about the effect of ageing populations dragging down growth and inflation, the opposite of what many people think will happen to global growth next year? These are the topics we will be discussing in next year’s weeklies.

Last week the FOMC decided to raise the fed funds rate to 0.75% and have pencilled in an extra rate hike in 2017. The media would have us believe that the faster pace of normalising the policy rate to its long term norm now estimated at about 3% reflects both a stronger US economy and expectations of outsized fiscal stimulus under a Trump presidency. An upward revision to Q4 GDP also tends to have some carry-forward into the Q1 level of GDP in the staff’s forecast exercise, thereby explaining the small 2017 revision. That leaves the tiny revision to 2019, which is hardly worth mentioning. At 1.9% that forecast remains at or below the US long term potential growth of about 2%, which in itself is at the high end of the staff’s latest estimate of 1.5% to 2%.

By contrast, the ‘dot plot’ of FOMC participants’ assessment of the appropriate monetary policy has captured the headlines. While it is true that the average level of the policy rate in December calls for three rate hikes of 25 basis points in 2017, instead of the two hikes envisioned at the September meeting, the new outlook still remains less aggressive than what participants envisioned in June, and in the interim most participants seem to have signed on to the latest staff research showing strong evidence that demographics can explain all of the decline in the long term neutral rate of interest rate to less than 1% in real terms (3% in nominal terms if inflation is stable at its target of 2%). A few members remain outliers in calling for the fed funds rate to rise to 3.5% to 4% but that dissenting view is increasingly out of sync with the majority.

If Congress does approve an outsized fiscal package, the staff forecast will be revised upward commensurately with the inescapable consequence of having to raise the inflation forecast for 2018 and beyond. In short, upward surprises in either economic growth or in the nation’s fiscal policy setting are likely to translate into a more aggressive Fed. The December FOMC decision is not yet the clarion call for higher rates at a faster pace, but it is a red flag for things to come if politicians think fiscal policy is a free lunch.

Turning to the topic of aging populations, a couple of recent papers from the IMF have detailed the palpable problem of aging populations and specifically aging workforces across Europe and Japan; highlighting the current and expected accelerating impact these will have on productivity and economic growth. Whereas an increase in the dependency ratio is an obvious drag to economic growth - the effects of an aging workforce itself is not obviously a hindrance to productivity. For an older workforce may make up for in experience what they may have lost in vigour and entrepreneurialism associated with youth; particularly in technologically advanced economies where the considered elderly may easily be just as effective in many fields of employment. Studies of this effect on advanced economies are scarce and ones accounting for the further potential advance of technology are fewer but these two papers, “The Impact of Demographics on Productivity and Inflation in Japan” and “The Impact of Workforce Aging on European Productivity” go some way to showing that these ‘headwinds can have a non-trivial impact on total factor productivity (TFP) and deflationary pressures.’

The age distribution of the workforce in Europe has shifted upwards over the past few decades but will accelerate in the years ahead to the extent that it ‘could reduce TFP growth by an average of 0.2 percentage points every year over the next two decades’. ‘But in countries where aging will be most pronounced—Greece, Hungary, Ireland, Italy, Portugal, Slovakia, Slovenia, and Spain—annual total factor productivity growth could be reduced by as much as 0.6 percentage points.’ Japan faces the same problem along with an overall declining population and few major economies are exempt from the predicament. Across the 24 European countries projected by 2030 all except Luxembourg will have between 15-25% of the workforce aged 55-64.

Countries that have already ridden the demographic growth boom and failed to invest those gains preparing for when these population pyramids become top heavy will face an increasingly uphill battle. Those with already unsustainable net foreign debts will have shrinking productivity with which to service these hefty debts whilst spending on increasing welfare costs. This problem is only exacerbated every time such necessary global deleveraging is pushed down the road and it will remain a long term risk to global growth and inflation prospects well beyond the next few election cycles and perhaps well into all of our retirements (or geriatric careers). We continue to believe that high quality investment grade debt from net foreign creditor regions represents a sensible investment in the face of such growth headwinds.

Changing demographics provided the idea for the Next Generation Global Bond Fund which we launched as a Guernsey based fund back in July. This fund is proving very popular with a UCITS version of this fund being launched today.

Wishing you a prosperous 2017.

The Weekly Update

The Italian Prime Minister Matteo Renzi has formally announced his resignation after losing the referendum on constitutional reform, potentially tipping the Italian economy into political turmoil. As well as submitting his resignation to Italy’s President Sergio Mattarella, Renzi also insisted he would not be available to lead a caretaker government and over the weekend Paolo Gentiloni, the former Foreign Minister, was appointed Prime Minister. Although many expected Renzi to lose the referendum, the size of the loss will surprise some commentators. With over 33 million Italians voting, more than two-thirds of those eligible, nearly 60% voted against a change to Italy’s constitution. In a speech after the vote, Renzi said ‘My experience in government ends here … I did all I could to bring this to victory’ adding  ‘If you fight for an idea, you cannot lose.’ The vote is the latest blow to establishment politics in favour of populist and anti-immigrant parties, following on from the Brexit vote and Trump's surprise victory. The biggest objection to the reforms was that it would have given the ruling party more power at a time when there was little faith in politics. On the back of the result the euro touched a 20 month low against the dollar (1.0506).

Elsewhere, some good news for Mexico last week as they successfully auctioned off eight deep water oil and gas blocks in the Gulf of Mexico as an ongoing policy to open up the country’s energy industry. Companies such as China Offshore Oil Corporation (CNOOC), Australia’s BHP Billiton, France's Total, Norway’s Statoil, Malaysia’s Petronas, BP and a number of US companies were all successful bidders with a number of joint ventures established.

Mexico’s relieved energy minister Pedro Joaquin Coldwell said, ‘This underlines Mexico is very competitive in the oil and gas sector’ adding, ‘Before the current administration ends in two years’ time Mexico will likely hold three more oil auctions for shallow and deep water, as well as onshore areas’. Government expectations were reportedly that it would have been content if just four fields had been auctioned so the result that eight were successful was an obvious boost. It is thought that over the next decade the fields auctioned yesterday will add around 900,000 barrels a day to Mexican output with the auctioned fields thought to contain an estimated 8.4 billion barrels of oil.

Also good news from China, where both global and domestic demand appear to have improved as trade data releases for November materially rebounded, exceeding market expectations. Exports gained 5.9% while imports were up 13%, in renminbi terms; this was the first month of positive export growth, measured in US dollar terms since March this year. We expect exports to come under pressure if the US does go ahead to restrict imports from China, although China has a multitude of options to turn to and is currently in talks with the UK, which we expect, could be one of China's closest allies going forward. Trade between the two nations stood at just under $80bn last year.

China’s imports jumped the most in over two years off the back of a surge in copper, crude, iron ore and coal demand. The combination of a weaker currency and stronger commodity prices suggests China’s PPI will continue to push higher. Higher PPI inflation should lead to increased corporate profitability, as these two measures have historically been positively correlated. Higher and more stable inflation has aided the PBoC in shifting to a more neutral monetary policy stance.

The Weekly Update

In its first international report since Donald Trump’s unexpected presidential victory, the Organisation for Economic Cooperation and Development (OECD) said that although the exact benefits of Trump’s proposed spending and tax cuts are unclear, it does expect his proposals to boost economic growth in the US. The OECD said the likely boost would improve US growth in 2017 from 1.9% to 2.3% and in 2018 from 2.2% to 3%. As for global economic growth, they have raised the outlook from 3.2% in 2017 to 3.3% and from 3.3% to 3.6% in 2018. The forecasts are based on the US government increasing spending in 2017 and 2018 by .25% of GDP, together with a cut in the corporate tax rate along with a cut in income tax. Together the 2 cuts in tax will represent approximately 1.25% of US GDP by 2018.

OPEC agreed to their first production cut in eight years with members on paper at least agreeing to a cut of 1.2million barrels a day. Headlines such as ‘OPEC resurrection’ ‘OPEC are back’ and ‘OPEC in the driving seat’ combined with a near 10% bounce in the price of Brent, welcome the news that OPEC and Russia are working together and Saudi and Iran are in agreement. However, the agreement depends on self-compliance of all the countries involved to keep to targets and there remains problems as to how to measure production and so this agreement will be extremely difficult to police. Countries such as cash starved Venezuela and Angola would love to take advantage of higher pricing and sceptical traders doubt if Iraq and Iran will be in compliance in just a couple of months’ time.  Also the promised reductions by non-OPEC members Russia and Mexico of 500,000 barrels a day is a huge proportion of the reduction and in the case of Mexico the cut looks more like a natural decline rather than genuine production compliance.

Towards the end of the week the attention was taken up by Italy's constitution referendum and the Austrians voting for a new Prime Minister over the weekend. Italian Prime Minister Matteo Renzi’s job was on the line if he was to lose. He had already said he'd resign if the nation rejects his political reforms, which polls and bond yields predicted would happen. In Austria the EU was hoping for an  independent pro-EU Alexander Van der Bellen being able to hold off the challenge of Norbert Hofer of the anti-immigration Freedom Party.

There was press speculation that the ECB could temporarily step up purchases of BTP’s (Italian Government Bonds) should Sunday’s result cause yields to spike. The suggestion in the Reuters report was that the ECB QE programme was flexible enough to allow for a temporary increase in purchases and that undertaking such a move would not necessarily need to be ‘rubber-stamped’ by the Governing Council, which as a reminder meets formally 4 days after.

Friday’s November non-farm payroll release showed 178,000 jobs added which was in line with expectations. The prior month’s reading of 161,000 jobs added was revised down to 142,000.  The unemployment rate fell to a nine year low of 4.6% from October’s reading of 4.9% and the participation rate dropped a little to 62.7%.  Average hourly earnings was an off setting factor to an otherwise expected and rather neutral report as month on month the -0.1% saw a 2.5% year on year number from the 2.8% previous report. This data release in conjunction with recent Fed commentary makes a December rate rise almost inevitable with the market pricing in a 100 percent expectation of an increase in rates. What is more challenging to determine is what a Trump Presidency really means for growth and inflation.

The Weekly Update

Last week, five months to the day since the EU referendum, Chancellor of the Exchequer Philip Hammond delivered the first Budget of the Theresa May Government; the first Autumn Statement to the Commons in light of Brexit. In brief: GDP growth forecasts lower by 0.8% and 0.4% for 2017 and 2018; planned borrowing to increase by £122bn for the next 5 years; some slender support for renters and affordable housing; some mollifying policies for the ‘just about managing’ or JAMS increasing the ‘national living wage’ and tempering some of the Universal Credit reforms; corporate tax will be cut to 17% along with a wide range of new tax reforms; and new fiscal targets of a 2% deficit with debts falling by 2020. Markets saw inflation expectations surge higher; also sterling rallied to 1.2435 during the statement but then fell to 1.2360 before the end of the statement as US data came out.

Before today, Chancellor Hammond had already referenced the UK’s ‘eye-wateringly’ high debt levels, yet today confirmed that borrowing for the next 5 years will increase a further £122bn to fill the black hole that has become apparent since the Brexit vote and increase in debt interest costs, however it will also help to fund a £23bn new ‘national productivity investment fund’ which will incrementally fund projects from transport infrastructure to high-tech innovation.

Perhaps an interesting technical oddity we noticed is the budget no longer misleadingly accounts for pseudo sterling gains from hedged foreign currency reserves when calculating the Public Sector Net Debt (PSND). Previously it had included such gains in sterling terms on the assets whilst omitting the corresponding losses from the hedging derivatives (from sterling weakness) because of odd Eurostat guidelines; last year this accounted for around £10bn that would have never materialised in the National Accounts and could have perhaps been even more significant for the recent months following Brexit and sterling weakness.

Another take on the UK finances since the Brexit vote comes from Credit Suisse’s 2016 Global Wealth Report which estimates that UK household finances are $1.5tn worse off, equivalent to an average $33k reduction in value of accumulated assets per adult. Should Anglo policies continue to diverge alongside potential Trumpflation this in-dollar-terms write-down may just be the beginning for UK residents and investors. The report also calculates a $3.5tn rise in global wealth to $256tn but that this ‘wealth creation has merely kept pace with population growth’ for the first time since 2008. With such population growth slowing and the risks to global trade increasing, overall global growth faces strong downward/sideways pressures that regional pockets of fiscal stimulus and infrastructure spending will likely do little to offset.

With Brexit and the election of Donald Trump as US President, 2016 has been a year of political change, perhaps even revolution. Populist politics is seemingly the new zeitgeist as voters have vented their dissatisfaction with rising inequalities blamed on globalisation and more liberal policy agendas instead favouring more conservatism and protectionist approaches to areas such as immigration and potentially trade. This trend is also spreading to Continental Europe where the Italian referendum on constitutional reform is due on December 4 but could end up being a protest vote against the incumbent government and ‘economic malaise’. The ongoing primaries for the French Presidential Election next year are also sowing the seeds for a departure from the status quo with François Fillon, who comfortably won his party’s primaries on Sunday, predicted to easily win the presidency based on current polling. The clear message is that people in France are dissatisfied and frustrated with the status quo. With 283 terrorist related deaths since January 2015, an unemployment rate still around 10 percent, momentum looks to be with the candidates offering change.

Whether politicians can actually make a real difference to ageing so-called “developed” economies, is debatable. Against a backdrop of shrinking populations, growth will be very difficult to come by in many countries over the next decade or two and continual political change being a likely consequence. That is not true for all countries though with those running current account surpluses, with strong NFA positions and faster growing populations being the obvious candidates for bond investors looking for attractive alternatives.