Last week the US Treasury curve continued to bull-flatten, with the spread between the 5-year and 30-year tightening to ten-year lows; historically this measure has been used as a recession indicator - the tighter the spread and more inverted the curve the stronger the trigger. However, at this stage of the cycle, we do not expect the US to enter into a recession. The tightening appears to be more a case that the US curve is sufficiently more attractive; the 10-year UST, for example, offers roughly 2% additional yield compared with the equivalent Bund and JGB benchmarks. The 10-year yield ended the week 6bps lower, at 2.34%.
US data releases last week included the October PPI which spiked to 5.5 year highs; with demand primarily driven by rebuilding post-hurricanes and following the wildfires. Headline CPI moderated in October, in-line with expectations, to 2%, while the core reading edged higher to 1.8%. Retail sales, also cooled in October, broadly in-line with market expectations and the November Empire Manufacturing gauge plummeted from its three year high. Import and export price indices also disappointed in October. The dollar (DXY Index) once again struggled to find its feet, falling 0.77% over the week.
The sell-off across the USD 1.3tn junk bond market grabbed market attention last week, according to ICE BofAML Indices, spreads across sub-investment grade bonds widened as much as 59bps, from the lows witnessed last month, to average yields of 6%. This is the second largest move this year; back in March spreads across the asset class widened 61bps in under three weeks. So, this could be one to watch in the coming weeks. As regular readers are aware we currently hold no junk bonds.
China’s bond ‘rout’ also hit the newswires last week, the yield on the 10-year benchmark crept above 4% for the first time in three years; the PBoC responded by injecting liquidity into the financial system and the yield eventually closed the week at 3.93%. Also of interest last week was a paper written by the NY Fed staff on ‘China’s Evolving Managed Float’, which concluded that “China’s recent approach to managing the fix, and exchange rate more broadly, appears to have been a success.” Increased visibility and predictability were highlighted as some of the reasons that have “helped desensitized global markets to fluctuations” in the renminbi cause by dollar moves. Noting that the renminbi “has held broadly stable” against the CFETS basket, the report underscored the “sharply scaled back currency market intervention” by Chinese policymakers. As of Friday’s close, the offshore renminbi is up 5.12% against the dollar so far this year, with carry at just over 4%.
Data releases out of China suggested some softening in activity in October, meanwhile, the housing market also cooled in October, resulting from sector tightening measures. Despite recent softer readings, “The economy continues to operate in a reasonable range in terms of production, employment, inflation and corporate profitability,” Liu Aihua, a statistics bureau spokeswoman said in Beijing, adding “The growth momentum remains good, laying a solid foundation to achieve the full-year targets.” As the country strives to manage financial risks, deleverage and push forth with supply-side reforms, economic growth is expected to slow, however, market speculations of a ‘hard-landing’ have ebbed and Chinese policymakers have reiterated their preference for slower and more sustainable growth; which is currently above the government's target.
A Thanksgiving holiday-shortened week will see further Brexit discussions as EU foreign and European ministers meet today; according to sources, PM May could look to get cabinet approval to double the ‘divorce settlement’, originally touted at EUR20bn. The new location for the European Banking Authority and European Medicines Agency will also be decided today. On Tuesday we will hear from Fed Chair Janet Yellen “In Conversation with Mervyn King” in New York, and the Chicago Fed National Activity Index could be of interest. Wednesday’s key event will be the UK’s Budget Statement; growth forecasts will grab market attention with Brexit concerns looming. Later we’ll get the FOMC minutes for the 2nd November meeting, we expect little change in rhetoric; a December hike is still penciled in. Mr Putin is to host discussions on Syria at a summit in Sochi; Turkish and Iranian presidents are due to attend. The preliminary reading for US durable goods orders in October may garner some attention, with market expectations at only 0.3% (vs 2% previously).
US bond and equity markets will be closed on Thursday for Thanksgiving; according to the American Farm Bureau Federation estimates that 46 million turkeys will be consumed and the average cost of feeding a group of 10 has fallen to the lowest level since 2013. In terms of data, we’ll see a number of PMI readings across Europe, and Germany’s Q3’17 GDP print, and the UK’s second reading. Also on Thursday, we’ll see the release of the ECB minutes. OPEC’s Economic Commission Board will gather in Vienna ahead of Nov, 30 meeting; expectations are for the continued enforcement of supply cuts into mid-2019. Black Friday will kick-off with Japan’s manufacturing PMI for November and the German IFO print. This will be followed by US Markit PMIs. The fate of South Africa’s long-term rating hangs in the balance, as Moody’s and S&P publish their reviews on Friday. South Africa is rated BB+ by both S&P and Fitch, and Baa3 by Moody’s so a one-notch downgrade by the latter could see the country’s long-term rating junked. As further delays are expected on the US tax front, Senate is now expected to vote on its version next week; this may see a continuation of the softer market sentiment tone this week. Also, through the week, news on the formation of a German coalition (and a possible fresh election) will grab market attention as will the unfolding events in Zimbabwe; where Mugabe could face impeachment.