Insights Investment

• The spread of the coronavirus has prompted a flight to safety contributing to a decline in US bond yields. Since the virus outbreak began there have been declines across the US yield curve with 10-year and 20-year yields declining 22bp and 20bp, respectively. This considerable downward move was accentuated by the perceived dovishness of the Federal Open Market Committee (FOMC) meeting. Notably, in the statement, the Federal Reserve (Fed) made a text change regarding “inflation returning to the Committee’s symmetric 2 percent objective” versus the previous reference to “inflation near” the same objective. Markets are now pricing in a 60% probability of a rate cut by the June meeting.
• European bond markets have not been immune to the coronavirus. Concerns about both the rapid spread of the virus and its potential economic impact have affected investor sentiment. The shift to risk-off has encouraged a bid for European government bonds which continue to perform strongly. Italian bonds (BTPs) have been a notable outperformer vis-à-vis both the core and the periphery. In addition to coronavirus concerns, BTPs have been supported by a reduction in Italian political risks. The outcome of regional elections has reduced the risk of near-term snap elections. BTPs reflected this reduced risk by rallying about 20bp on the first trading day after the election. In the UK, the Bank of England decided to leave the Bank Rate at 0.75%, despite softening economic data and the commencement of the Brexit transition period.
• The past week has seen the coronavirus escalate in China, which stands as both the origin and current epicenter of the virus. According to the World Health Organization (WHO), by 28 January the number of confirmed cases had risen to 4,537 in China with a death toll of 106. Forceful measures have been implemented within and outside mainland China. Since President Xi and the State Council ordered “all-out prevention and control efforts” almost all cities in Hubei provinces (where the virus originated) are locked down with 30 of the 31 provinces in China adopting the highest level of response mechanism. Furthermore, the Lunar New Year holiday has been extended by two days. While it is still early days, the outbreak is an unexpected shock for China’s economy and will likely have a sizeable impact on global economic activity.
• US corporate spreads widened 6bp to 99bp as concerns about coronavirus on growth, particularly in China, weighed on sentiment. Energy and travel continued to be the primary underperformers, although telecoms also weakened on softer earnings. Given the outbreak and the Fed meeting, there was very little issuance. Similar concerns were reflected in European credit markets. European investment grade and high yield (HY) spreads pushed wider over the week. European HY issuance has been strong so far this year, reflecting the strength in demand for HY bonds, both BB- and B-rated. 

 Chart of the Week: US 10-year Treasury yields fell on coronavirus fears and a dovish FOMC meeting

Source: Bloomberg. Data as at January 31, 2020.

Source: Bloomberg, January 31, 2020

Economic calendar

February 3: China Manufacturing PMI; US ISM Manufacturing PMI.
February 4: Reserve Bank of Australia interest rate decision
February 5: US non-ISM manufacturing PMI
February 6: US initial jobless claims
February 7: US nonfarm payrolls; Canada unemployment data.

• Fears over China’s mystery new coronavirus encouraged a risk-off theme for markets, with over 800 confirmed cases of the virus globally. Global government bond yields fell and the news weighed on energy and travel sectors, particularly ahead of the Lunar New Year over which millions of people travel. China has locked down over 10 cities in response to the outbreak. S&P said Chinese GDP growth could fall by 1.2% if spending on areas such as discretionary transport and entertainment drops as people stay at home to avoid contracting the virus. Treasury yields fell by 8bp.

• Flash PMIs were a focus for the market on Friday, with Germany and the UK delivering strong numbers. According to IHS Markit, Germany’s flash composite PMI came in at 51.1 (vs. 50.5 expected), the highest level in five months. Meanwhile, the UK’s flash composite PMI reading hit 52.4 in January, up from 49.3 in December, which may have decreased the chance of a UK rate cut next week. However, the positive data was apparently outweighed by other concerns as bund and gilt yields fell. The eurozone flash composite PMI was flat month-on-month.

• In Europe, Luigi Di Maio stepped down as leader of Italy’s Five Star Movement this week, causing volatility in markets. Italian spreads narrowed by around 3bp. Di Maio will remain foreign minister, so he will not lead a breakaway group out of government. He has been temporarily replaced as party leader by long-standing fellow party member and serving senator Vito Crimi, with a leadership contest to take place in March. Separately, the European Central Bank launched the review of its monetary policy strategy, which is expected to conclude by the end of 2020. There was little else in way of news from the meeting, with no indication of change on the horizon for its policy stance.

• In credit markets, US corporate spreads tightened as the Treasury announced it would issue 20-year Treasuries caused 20-year corporate spreads to rally on the expectation of greater liquidity and price transparency. There was moderate new issuance in the US primary market from financials, retailers, and oil and gas issuers. Meanwhile, the European credit market was quiet, owing in part to the corporate earnings blackout period. The European credit market held up well compared with other risk assets, like equities, which suffered on the coronavirus news.

• Strong flows into emerging market bonds continued, with inflows accelerating to their highest level in five weeks. A total of $2.6bn had been added on the week at time of writing, which brings the year-to-date flows to $6.9bn.

 Chart of the Week: Sterling spot rate bounces on strong UK flash composite PMI print

Source: Bloomberg and US Bureau of Labor Statistics. Data as at January 24, 2020.

Source: Bloomberg, January 24, 2020

Economic calendar

• Monday: Germany January Ifo Survey, US December new home sales
• Tuesday: US preliminary December durable goods orders, Bank of Japan release summary of January meeting
• Wednesday: US Federal Reserve decision; Germany February GfK consumer confidence; France January consumer confidence; Italy January consumer confidence, manufacturing confidence, economic sentiment, December PPI; US weekly MBA mortgage applications, December advance goods trade balance, preliminary December wholesale and retail inventories, pending home sales
• Thursday: Bank of England decision; Germany January unemployment change, preliminary January CPI; Italy preliminary December unemployment rate; eurozone January economic confidence, final January consumer confidence, December unemployment rate; US advance Q4 GDP, weekly initial jobless claims; Japan December jobless rate, retail sales, preliminary December industrial production
• Friday: UK January GfK consumer confidence, December consumer credit, mortgage approvals; China January composite PMI, manufacturing PMI, non-manufacturing PMI; Japan December housing starts, construction orders; France preliminary Q4 GDP

• The US and China signed a ‘phase one’ trade deal on Wednesday that signaled a potential end to ongoing trade tensions between the two countries. The agreement contains a promise by China to spend at least $200bn on US goods and services over the next two years, stricter rules on theft of American intellectual property and a pledge by China not to manipulate its currency. However, the market reaction was muted as the deal fails to address major flashpoints of previous US-Chain tensions such as commercial cyber theft and China’s use of industrial subsidies. The 10-year Treasury ended the week 2bp higher.

• In US credit, corporate spreads were unchanged as tight valuations limited gains from the US-China trade deal announcement. Earnings season kicked off with strong results from US banks and is set to continue with industrials reporting accelerating next week. Apart from the banks, there was limited new issuance with SQM, Western Gas, EQT and Blackrock.

• In European government bonds, the heavy issuance from last week continued with Belgium, Spain and Italy all coming to market. The €32.5bn issuance this week has been well absorbed with the 10-year Spanish issue garnering over €53bn of orders, surpassing the previous record of €47bn. Italy, Belgium, Cyprus and Ireland also saw record demand for their recent issuances as well, indicating healthy investor demand for positive-yielding European bonds (see chart below). In bond yields, the UK was the main mover this week with 10-year gilt yields falling 13bp on the back of soft UK inflation and GDP data.

• In emerging markets, there was positive economic data out of China as Q4 GDP of +6.0% year-on-year was in line with expectations while retail sales, industrial production and fixed asset investment all surprised to the upside. The news caused the Chinese yuan to strengthen to a six-month high of 6.8660 against the US dollar.

Chart of the Week: Spanish yield premium over Germany tightens (Spain-Germany 10-year yield spread)

Source: Bloomberg and US Bureau of Labor Statistics. Data as at January 17, 2020.

Source: Bloomberg, January 17, 2020

Economic calendar

January 21: US unemployment, EU ZEW economic sentiment index
January 22: US housing prices and existing home sales
January 23: ECB meeting, US jobless claims
January 24: EU/US flash PMI data

• US-Iran tensions escalated at the end of last week due to the assassination of Iran’s top military commander Qassem Soleimani. Markets reacted sharply to the event, with Brent crude oil prices reaching $69/bbl during the week, but they have since returned to the levels prior to Soleimani’s death at $66/bbl. After the assassination, US sovereign debt rallied over the week, with 10-year Treasury yields down almost 9bp on Monday. Tensions seem to have eased but the situation remains uncertain.

• In the US, payrolls increased by 145,000 in December and unemployment stayed at 3.5%. The services purchasing managers’ index (PMI) was revised up to 52.8, the highest reading since July. In US credit, spreads were marginally wider as a wave of new supply and some early-year selling from Asia offset the improving geopolitical backdrop. New issuance was over $60bn, the fourth-busiest week in history with over 50 companies issuing, including numerous European banks, Energy Transfer Partners and Western Gas, along with issues from Indonesia and Mexico.

• In European markets, Italian spreads tightened at the end of the week partly driven by lack of supply and also as headlines emerged about the reduced likelihood of a referendum on constitutional reform. In Spain, political uncertainty waned as a coalition deal was agreed, though this raised the prospect of past labor and pension reforms being reversed. In the UK, outgoing Bank of England Governor Mark Carney mentioned that interest rates may be cut in the future. This led the pound to drop over Thursday night but the currency recovered on Friday.

• In European credit, there was a flurry of new issuance to start the year, led by several financials at the start of the week. Spreads of new issues outperformed the secondary market. The eurozone services PMI was revised up to 52.8 meaning that the composite reached 50.9, the highest since August when it reached 51.9.

• In emerging markets, the year started off with strong inflows, with JP Morgan reporting US$1.7bn in inflows to bond funds, with the majority (US$1.1bn) into hard currency funds and an additional US$1.1bn into equity funds. Volatility in oil markets benefited oil producers such as Russia but at the expense of importers such as Turkey. Markets will be closely watching the central bank of Turkey next week, with forecasters expecting a 50bp rate cut. Meanwhile, China’s car sales fell for the second year in a row, with a fall of 7.5% in 2019.

Chart of the Week: The price of Brent crude oil ($/bbl)

Source: Bloomberg and US Bureau of Labor Statistics. Data as at January 10, 2020.

Source: Bloomberg, January 10, 2020

Economic calendar

13 January: UK GDP, trade balance, industrial and manufacturing production
14 January: US CPI, China trade balance
15 January: UK and France CPI, RPI and PPI, US mortgage applications and PPI, signing of US-China phase one trade deal
16 January: EU27 new car registrations, German CPI, US retail sales and jobless claims
17 January: China Q4 GDP, retail sales and industrial production, UK retail sales