Weekly fixed income review

Market review

Week to May 17, 2019

US Treasury yields fell across the board mid-week and two-year yields hit a 15-month low of 2.14% following the release of weak retail sales and industrial output data. The unexpected decline in April’s retail sales was driven by a decline in motor vehicle purchases. Industrial production fell 0.5% representing the third decline in production this year. Following these releases, the Atlanta Fed revised down its 2Q GDP growth estimate to 1.1% from 1.6% annualized. China reduced its long-dated Treasury holdings by the largest amount in over 2 years in March with net sales amounting to US$20.45bn. This compares with US$1.08bn net purchases in February. While these sales are most likely an exercise in currency reserve management rather an active diversification, it comes amid an escalating of trade tensions between the US and China and prompted speculation that the reduction was some form of potential retaliatory measure. Treasury yields retraced higher later in the week as data releases turned positive – homebuilding increased more-than-expected in April, weekly jobless claims fell and the Philadelphia Fed’s business conditions index gained in May.

In Europe the 5s/30s EUR curve flattened about 4bp over the week. European rates markets were largely risk-off driven by deteriorating US-China trade discussions and political uncertainty in Italy. Investors were also wary of the threat of US tariffs on EU auto exports; although concerns were assuaged later in the week after headlines suggested that President Trump would delay any tariff decision by up to six months. Italian spreads have come under pressure on rising tensions between the leaders of Lega Nord and the Five Star Movement, Matteo Salvani and Luigi Di Maio, ahead of the forthcoming European parliamentary elections. Sentiment also deteriorated following a quote from Salvani that “Italy could break EU fiscal limits”. Beyond the supportive macro and geopolitical environment for European duration, Japanese investor inflows have also helped cap European government bond yields. Recent Japanese investor sovereign purchase data details that Japanese investors bought EUR25bn of French bonds – a large purchase in historical terms and represents a material jump in Japan’s holdings of outstanding of French bonds.

US credit markets ongoing negative trade headlines pushed spreads 4bp wider to 118bp, although there has been some recovery following the headlines that auto tariffs will be pushed out the next 6 months. In emerging markets, the Mexican peso declined 0.4% on Thursday after the central bank left borrowing costs unchanged at 8.25%. While the central bank has stated its belief that the recent pickup in inflation is transitory, its focus on wage and cost pressures leaves limited scope for rate cuts over the remainder of the year. Brazilian assets weakened after the release of bearish economic forecasts and concerns over the government’s ability to get its flagship pension reform through Congress. The Brazilian real has now slumped to its lowest level since October.

Figure 1: 10-year Italy-Germany yield spreads

Figure_1_10-year Italy-Germany yield spreads_17_May_2019

Source: Bloomberg. Data as at May 17 2019

Bloomberg table 17 May 2019

Source: Bloomberg, May 17, 2019

Economic calendar

May 20: Japan Housing Loans
May 21: Eurozone OECD economic outlook
May 22: UK CPI
May 23: Japan CPI
May 24: US durable goods orders

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