The Weekly Update

The main focus last week was on the FOMC meeting, where as widely expected the Fed increased rates by 25bps to 1%-1.25%. As markets had been expecting a hike since March, they were more focused on the future trajectory of hikes and of course the balance sheet taper details. Some further details were given on the USD 4.5tn balance sheet, with the Fed’s ‘caps’ for the monthly portfolio run-off to be set at $6bn in Treasuries and $4bn in MBS. A number of Fed officials have said the run-off programme could run until the balance sheet shrinks to USD 2-2.5tn; bear in mind the pre-financial crisis balance sheet stood at a ‘mere’ USD 800bn. No official start date was mentioned however the market expects a September announcement with Fed Chair Yellen, stating the plan could be implemented 'relatively soon'. On the rate path, the majority of Fed members have forecast one more rate hike this year.

With benign US inflation still on everyone’s minds, the central bank noted the recent decline and revised its core PCE forecasts lower to 1.7% (from 1.9%) adding however, that it will not let data ‘noise’ prevent it from continuing on its course of normalisation. Data noise did however impact the market ahead of the FOMC meeting; weak retail sales readings in May and the disappointing CPI releases for example saw the 10-year UST yield fall to year lows of 2.10%. The broadly hawkish post-hike Fed tone did see yields drift slightly higher, but the week ended with weak housing data and the largest drop in the Michigan consumer confidence since October 2016, coupled with dovish inflation comments from Fed members Kashkari and Kaplan, resulting in lower UST yields; the benchmark 10-year ended the week 5bps lower at 2.15%. A less data heavy week ahead sees the release of Q1’17 current account balance later today, existing home sales for May on Wednesday, followed by Markit PMI data on Friday. There will also be a number of Fed members speaking this week; markets will be looking for any further clues on the balance sheet normalisation program and indications for a September hike.

Meanwhile, China data for May was released broadly in-line with market expectations; retail sales, for example, was up 10.7% yoy in May and FDI. The IMF upgraded its growth forecast for China to 6.7% for this year and 6.4% until 2020 highlighting that the country’s current stable growth gives policymakers room to press on with economic reform, adding that ‘some near-term risks had receded’. As the Chinese economy remains stable and FX reserves have increased, Beijing announced that its holdings of US Treasury securities have risen to a six-month high. With the renminbi maintaining stability against the recent volatile dollar, coupled with Beijing's push to deleverage, the PBoC did not move to lift OMO rates in-line with the the Fed move. Looking ahead this week, there is not much in the way of key economic data, however, investors will be focused on the MSCI decision on Tuesday where the index provider will announce whether or not it will be including China’s USD 7tn A-Shares within its emerging market stock index.

Elsewhere, Qatari bond yields ended the week slightly lower, as there was no material change to the Qatar-Gulf diplomatic dispute; the longer-end of the yield curve is roughly 3 points higher from June-lows. Although the news flow is limited, the general feeling is that a negotiated settlement, lead by Kuwaiti leaders, is best for all parties. Over the weekend Qatar also stated that it will keep pumping gas to the UAE ‘ who are considered like brothers’.

With the data light week ahead, events such as the commencement of Brexit negotiations, today, and the Queen’s speech on Wednesday, will dominate market focus. Also as mentioned MSCI is due to consider China, and Saudi Arabia, South Korea and Argentina for inclusion in its Emerging Market Index, the latter three being on a watch list. As the index is considered the most ‘important index provider’, any decision made regarding the former countries will no doubt have a huge impact on their stock markets.

The Weekly Update

Last week market focus was dominated by the unfolding events in the Middle East; where Bahrain and Saudi Arabia, and subsequently UAE and Egypt abruptly cut diplomatic ties with Qatar; alleging links with “terrorism and extremism”, and Iran. Oman and Kuwait, other members of the GCC remained neutral; with Kuwait leading mediation talks. Donald Trump also offered up Rex Tillerson to aid in the negotiation process; Tillerson has past experience within the Gulf region having dealt with the likes of Saudi Arabia as former CEO to Exxon Mobil. Mid-week, S&P moved to downgrade Qatar’s rating one notch to Aa3 (negative), bring it in-line Moody’s Aa3 rating. Fitch has maintained its AA (stable) rating suggesting that it is too early to see the true impact, if any, on the Emirate’s strong economy, stating the sovereign's ‘net foreign assets worth over 200 per cent of GDP mean that the sovereign credit profile is highly resilient to external shocks. As the situation evolves, our assessment will focus on effects on the sovereign's external and fiscal deficits’.

Qatar sovereign and quasi-sovereign bonds were roughly 10-25bps wider in spread over the week; so a lot more resilient than most market makers ha expected. This was partially offset by the gains in Saudi government and government-owned entities we hold. We will continue to monitor the situation this week, however, for the moment we are neither looking to buy nor sell out of Qatari holdings, instead maintaining positions with up to 4 credit notches protection, thus offering an attractive spread over similar bonds. With no new developments over the weekend, Qatar bonds have traded up so far today (at time of writing).

Elsewhere, former FBI Director Comey’s testimony was pretty much a non-event in the US; the dollar gathered steam into the end of the week, gaining 0.58% (DXY Index), but still close to pre-election low levels, and 10-year US Treasury yields nudged up 4bps over the week, to 2.20%. This week will see the release of the May monthly budget statement, where expectations are for a USD 87bn deficit. PPI and CPI readings will be released on Wednesday, CPI expectations stand at 0% mom thus 2% yoy, down from 2.2% previously. Retail sales data will also be of some interest; the control group reading (a component of GDP calculations) is expected to come in at 0.3%, up from 0.2% in April. The all important FOMC meeting follows, where we expect the Fed will move to tighten by 25bps, taking rates to 1%-1.25%; still historically low levels. The Fed is also expected to announce its plans on shrinking its balance sheet, to commence in September, and update economic and financial projections; core inflation for example may be revised lower.  Finally, the end of the week will see a number of economic data prints, with the likes of housing starts, building permits, University of Michigan sentiment, and Empire Manufacturing for June, which is expected to come in at 5, from -1 previously.

In Europe, the ECB upgraded eurozone growth forecasts and kept rates on hold. Meanwhile, the UK elections were of much market focus into the second half of the week; the conservative party lost a number of seats and parliament ‘hung’ in the balance. The week ended with the announcement that the UK Conservative party reached a deal with Northern Ireland’s Democratic Unionist Party (DUP) for Theresa May to remain as PM and proceed with Brexit negotiations which are expected to be ‘softer’. Sterling swung around on Friday, falling as low as 1.2636 against the dollar intra-day, eventually settling at 1.2746 against the dollar, 1.10% lower on the week.

This week will see a continuation of CPI and PPI, and trade date across the UK and Europe, EC employment releases for April will also be of some interest. No doubt eyes will remain on the developments within the UK government. Theresa May will today come face to face at a gathering with her 1922 committee of  backbenchers; a meeting which was brought forward a day. A number of reports have come out over the weekend and this morning suggesting May could be overthrown and replaced; George Osborne claims May is a ‘dead woman walking’, while David Davis and former Tory leader, Michael Howard have expressed the need for stability and togetherness stating May is the right person to continue the Brexit negotiations.

Away from politics, economic data releases from China were broadly positive. FX reserves beat market expectations, and remained above the USD 3tn level; as a result Beijing announced an increase in US Treasury holdings. Trade data beat expectations, with imports and exports up from April. Inflation numbers also came in pretty much in line with the market consensus, with for example CPI 1.5% yoy up from 1.2% previously. This coming week is a relatively quiet one for China data with the main feature being retail sales, which is expected to come in unchanged from April at 10.7% yoy.

The Weekly Update

Another positive week for credit saw the yield on the 10-year UST fall over 8bps after US employment data broadly surprised to the downside; in fact the benchmark Treasury fell to its lowest level this year. The non-farm payroll reading was released at +138K, with a net revision over the last two months of -66K; so much weaker than expected headline numbers for economic bulls. The unemployment rate fell to 4.3%, due to the participation rate dropping to 62.7% from 62.9%, and average hourly earnings were released at 0.2% equating to 2.5% yoy, below expectations. The dollar remained on the back foot last week, the DXY Index fell 0.75%; the greenback is now trading down at levels last witnessed in October last year.

We think the Fed will still tighten this month despite the broader disappointing economic data prints, however, this does question the future outlook, as the Fed, have both the funds rate and balance sheet situation to contend with; too much activity on either or both could be recessionary. Markets will be watching US data releases keenly this week: with the likes of Nonfarm productivity, factory orders and Markit PMIs on Monday; market expectations are for no change to the services reading, at 54. Tuesday sees the JOLTS job openings with consumer credit for April out on Wednesday. Markets will be listening closely to Comey’s testimony on Thursday, with initial jobless claims the only key data release, and Friday will see April’s wholesale inventory release.

Elsewhere the renminbi had a very positive weak, gaining 0.67% (spot) against the dollar; year to date the onshore currency (CNY) is up 4.23% while the offshore renminbi (CNH) has gained 5.10%, on a total return basis. Last week witnessed incredible funding pressures in the CNH arena with short rates hitting ~43% in HIBOR, the Hong Kong equivalent to LIBOR, on Thursday. As these rates are higher than US rates renminbi investors get paid to buy and own the currency forward - the amount fluctuates with interest rate movements. That’s not to say one would get paid 42% for the month, however, the further along the yield curve you go the wider it gets. We took advantage of this across the Renminbi strategy by actively managing the the renminbi overlay. We extended in total 75% of our overlay, out along the curve selling our shorter dated positions and buying longer term positions; out to 45 days to lock in this funding pressure. On average the strategy locked in a pick-up of between 4.6% and 5.1%, annualised for the term of the position.

This week opens with global services PMIs; we woke up to China’s strong Caixin PMI release, up at 52.8. China’s foreign reserve reading this week will be of some interest also, with markets expecting a pick-up to USD 3.048bn. Elsewhere, we heard of the atrocious London Terror attacks over the weekend, this comes ahead of the UK elections this coming Thursday; the polls remain very split. Also on Thursday we will hear from the ECB, and the Q1’17 GDP reading for the euro area will also be of some interest.

The Weekly Update

Last week market focus was dominated by geopolitical tensions in the US and Brazil. President Trump did not have an easy week after former FBI director James Comey (who was previously sacked by the US President) alleged in a memo that Trump attempted to obstruct a federal investigation into the former National Security Advisor, Michael Flynn. This sent risk markets screeching to a halt, further exacerbated by media reports suggesting Trump could/should be impeached. Some semblance of normality followed the knee-jerk reactions, and the appointment of Former FBI Director, Robert Mueller to act as special counsel to investigate Russia’s involvement in the US elections eased market concerns somewhat.

The DXY (dollar) Index did however retreat further over the week, falling 2.10%, and the Treasury market benefited from the risk-off tone, with the yield on the 10-year falling over 9bps to 2.24%. Markets will focus on Trump's first presidential foreign trip which started in Saudi Arabia over the weekend; where counterterrorism measures and USD 110bn worth of arms deals (amongst other policies) were discussed. He is off to Israel today, followed by Italy and the Vatican, eventually headed to NATO and the G7 summit in Sicily later this week.

Meanwhile, the Fed reiterated that it will be ignoring current political noise and recent market volatility and is due to stay on course to raise rates twice this year. Cleveland Fed President, Loretta Mester commented that one must ‘look through those temporary fluctuations in both economic and financial data and focus on… the medium-term outlook’, adding the Fed should ‘remain very vigilant against falling behind, especially  given the low level of interest rates and the large size of our balance sheet’. Meanwhile St. Louis Fed chief, who is forecasting only one further rate hike over the next couple years, said he feels the Fed is ‘overly aggressive relative to actual incoming data on U.S. macroeconomic performance’ , which he sees as ‘relatively weak’. Once again the Fed remain split regarding the tightening cycle; we expect the USD 4.5tn balance sheet will come into play as a further tightening tool. We wonder whether there will be any further enlightenment with a steady stream of Fed members speaking today and tomorrow. A rate hike next month remains firmly in place; despite spikes in volatility through last week which saw the futures market price all number of probabilities for a Fed hike in June.

Markets across Brazil also had a tumultuous week; as corruption allegations and impeachment calls against President Michel Temer mounted. The country’s stock market plummeted a massive 8.8% on Thursday and the Brazilian real witnessed its largest drop since 1999, falling over 7%. Brazil’s 5-year CDS over ~20% over the week as a result, to ~250bps. To add some context, Russia’s 5-yr CDS ended the week trading at 152bps.  Having never favoured Brazil issuers amongst our portfolios, regular readers of our daily comments will recall our concerns over the country’s Petroleum company, Petrobras being highlighted on Tuesday. Rated sub-investment grade, we calculate the company's bonds have been trading ‘expensively’ for some time, and continue to do so despite the massive 5-7 point slide on Thursday.

Elsewhere, China’s economic data prints came in pretty much in-line with expectations and the offshore renminbi gained 0.35% against the dollar over the week, on a spot basis. The currency is now up +3.4% against the dollar year to date, on a total return basis. Meanwhile, on Tuesday the central bank along with the Hong Kong Monetary Authority announced plans to establish the ‘China-Hong Kong Bond Connect’, which would create a platform of access between the two nations’ bond markets. Bond connect would allow investors access to China’s government bonds without a quota or other technical hurdles. Whilst it is unusual for international investors to access a bond market in this way (usually bonds are traded OTC) it does make access easier, thus a positive.

The opening of the Chinese bond market is still at a very early stage given that international investors represent a tiny fraction of the overall market. International investors will inevitably hold more RMB assets in due course, and it's important for international investors to be able to access investments with renminbi exposure if the renminbi is going to be widely accepted as a major reserve currency, which we think it should. Initially the focus will be on northbound flows, but eventually it would seem that southbound flows will be allowed as well. That opens up an interesting possibility for domestic Chinese investors looking for other RMB instruments elsewhere, perhaps CGB futures in HK, for example.

Bond Connect is just one of many initiatives that will help the internationalisation of the RMB. At the moment though, internationalisation of the renminbi is hindered by the perception of investors that the renminbi has been weakening. However that perception is largely incorrect with CNH gaining over 10% against the euro and 15% against sterling over the past 3 years with 5% and 12% gains against those two currencies over 5 years for example. The renminbi has fallen against the US dollar but in reality, it's the dollar that has been strong rather than the renminbi being weak. This perception, even if it's not true, does reduce the appetite of foreign investors to hold renminbi assets. That attitude will change at some point and inbound capital will likely pick up from the very depressed levels that we see today.  

Looking forward to the week ahead, with relatively light US economic data last week, this week will see the release of the much watched Chicago Fed National Activity Index, PMI data, Q1’17 GDP reading, which is expected to come at 2.3%, and the Fed’s favoured inflation number, the core PCE print. Elsewhere in Europe we will see the release of the German IFO print, Eurozone flash PMI reading and the second estimate of UK Q1’17 GDP. Japan’s CPI reading will be of much interest at the end of the week, where market calls are for +0.4% (from 0.2% previously).

The Weekly Update

Further weakness was seen Friday in the US economic data as both Retail sales and the CPI index came in lower-than-expected although previous revisions offset somewhat. This caused US Treasury yields to finish the week around 6bp lower from last Monday’s level and moved the futures market to drop below 80% for a June 14th Fed rate hike, still very much odd’s on. This week we have limited data in the US with Empire Manufacturing today and Capacity Utilisation (CU), Industrial production (IP) along with housing starts tomorrow and the Phili Fed and Leading index on Thursday. Not much to impact markets with IP the focus. Of course we do have a number of Fed members speaking which is always of interest and watch out for any cyber-attacks coming across Twitter from the President of the United States.

The EU is also rather lacklustre in terms of economic evidence this coming week, with just Italian CPI and Greece GDP today, focus will be on tomorrow with the UK’s RPI, CPI and PPI releases as well as EC trade, Germany’s ZEW, French CPI and Italian GDP. Wednesday EU CPI data, UK unemployment and Italian trade are the highlights and Thursday French unemployment and UK Retail sales may be of interest. We close the week looking at Germany’s PPI and the ECB’s Current account.

Overnight we had Chinese IP for April at 6.5% YoY, lower than the 7% expected we also had Retail sales at 10.7% YoY, a tad weaker than expectations. We also had Japanese PPI coming in at 0.2% against -0.1% and Thai GDP YoY at 3.3% better than the 3.1% expected. Tomorrow the RBA minutes from their May meeting will be watched as the statement after the meeting was slightly more upbeat than those of April, we also have New Zealand’s PPI data and Japan's Tertiary Industry Index to contend with. Wednesday the attention will be with Japan as Machinery orders, CU and IP take centre stage although Aussie wages and Malay CPI are also on the agenda. Thursday Japan's GDP and Foreign bond buying data, Australian unemployment and New Zealand consumer confidence lead into Friday and Philippine and Malaysian GDP close the Asian week.

Latam is also looking at a quiet week with Mexican International reserves Tuesday, Chilean GDP Thursday and Colombian GDP Friday.

More of interest could be Russia where we get CPI, GDP and the intriguing Gold and Forex reserve data which is expected to continue to move higher. The last release was at $398.8 billion with the recent low, April 2015 at $350.5 billion, way below the $520 billion levels seen in 2013 before the fall during 2014 of around $132 billion. We know the Russian central bank is active in the Forex market adding to their foreign currency as the oil price has stabilised above $50 making Russia’s production profitable again. They also have one eye on the Ruble which is trading around 57 to the US dollar. You may recall Russia effectively devalued the Ruble during the oil weakness of 2014/2015 pushing it down from the USD 34.00 level to as weak as 82.00 in early 2016, so the move to today’s level is a 32% Ruble strengthening from the lows which means the oil revenue in US dollars buys far less Rubles to pay the production costs; this warrants monitoring especially if you are a Russian central banker sitting under President Putin’s gaze.
 

The Weekly Update

We enter the week with the markets calm after the win in France for Macron with a lead of over 20%, more than expected. Market reaction is limited with the Euro up slightly and French government bonds stable as movement over the last couple of weeks had already priced in the result. Elsewhere news that Russia will extend output cuts in agreement with OPEC has supported oil and a third monthly rise in China’s reserves up to $3.0295 trillion helped calm Asian forex markets.

This week the US data, a typical post Non-Farm Payrolls week, is skewed to the end of the week with PPI on Thursday and CPI and Retail sales on Friday, but we do have a number of Fed speakers throughout the week to catch the headlines as well as Mr Trump and his twitter account to contend with.

Europe has a little more action with German factory orders just announced up 1% with calls of 0.7%. Tomorrow we get German IP and Trade data as well as Italian Retail sales followed Wednesday by French and Italian IP. Thursday is the UK’s turn with the BOE announcement, expect sharply unchanged, IP, Trade and construction output. We also have the EC Commission’s Economic Forecasts but these are hardly ever mentioned let alone have an impact. Which brings us to Friday once more and German GDP and CPI, EC IP, Spanish CPI and French Non-Farm Payrolls, which may get a mention in Paris but markets hardly take notice of.

In Asia, as mentioned above, China’s reserves are up again as the trade surplus came in at $38.05 billion almost $3 billion higher than the calls while in Australia Building Approvals came in a disastrous -13.4% m-o-m but the NAB business confidence remained stable. Tuesday we have Aussie retail sales to add to the picture but the rest of the week is about Japan with official reserves and the leading index Wednesday and Trade on Thursday although we do have Singapore’s Retail sales on Friday for those who care.

Latam dominant data starts with Chilean CPI and Trade later today followed by Mexican CPI tomorrow and IP on Friday. In the middle we have Brazilian retail sales on Thursday to observe. We still don’t hold Brazilian bonds as they continue to trade rather expensive given the credit rating, but we do have sizeable positions in Mexico through the quasi sovereign Pemex and indeed the Government bonds, all denominated in US dollars. These assets have performed very well this year so far. By way of as an example the Pemex 5.5% maturing June 2044 is up in price 5.5 points since year end and at a spread of 344bp remains a long way over the fair value spread of 160bp for this Baa1 rated credit. In fact if this bond moved to fair value it would rally a further 26 points in price.
 

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.