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.