Candriam : Short duration bias on the mid portion of US curve

Better macro-economic data emanated from the US over the month of August with encouraging employment figures and consumer confidence prints pointing towards an improving activity cycle. In spite of weaker ISM statistics, the probability of recession appears to be ebbing away. The inflation picture is also following an upward trend with improving CPI, wages and housing market numbers…….

Sign up for our free newsletter to receive weekly news from BONDWorld. Click here to register for your free copy 


Candriam Fixed Income – Monthly Strategic Insight


During the Jackson Hole meeting, several FOMC members discussed the possibility of a rate hike in 2016. Chairman Janet Yellen indicated that the case of a rate hike has strengthened in recent months and Vice president Fischer stated that evidence showed that the economy was strengthening. As a result of an improving macro-economic outlook and a slightly more hawkish Federal Reserve rhetoric,we are keeping our short duration bias on the US 7 and 10 year which we express through options.

US remains our preferred linker market

The US is in a reflation phase. Wage and consumer inflation sub-indicators are bouncing back while energy inflation should also help push headline inflation higher in the coming months. In Europe, headline data remain low but base effects should be positive in H2 2016, as oil is stabilizing, and should help inflation pursue its increase. The dovish bias of global central banks should continue, as the BOE added further stimulus in a quest to prevent post-brexit hazards. The Bank of England not only cut rates by 0.25%, but also expanded its QE program by committing and additional £60 billion in buying sovereign bonds) and an additional £10 billion pounds  for corporate debt.

We continue to maintain a large overweight bias on the inflation-linked debt asset class, principally via the US market (+0.25 CTMD)
, which saw an outperformance of 1% compared to the nominal rates in August. Our strong conviction on US linkers is driven by inflation dynamics, valuations, monetary policy and the relative BEI carry. To a lesser extent, we are also exposed to the EMU linkers and we partially took profits on our UK positions, which performed very well over the course of the month.

 Defensive on Euro non-core countries overall

Overall, non-core countries continue to be strongly supported by the very accommodative stance of the ECB. Additionally, in the wake of weak inflation data, the Central bank is likely to announce an expansion or an extension of its QE program by year end. The resilience of economic data (PMI prints etc) following the Brexit vote outcome gave the ECB extra time to assess the best option. Furthermore, the supply/demand dynamics appear to be favorable as the net cash flows (Supply – QE purchases) are negative.  However, it is important to note that the long investor positioning on both core and peripheral sovereigns has increased substantially.

Having significantly reduced our allocation to European peripheral bonds over the past months, we currently hold a more defensive stance to the asset class. The increased political risk in Italy, heightened by the up-coming vote on the constitutional referendum, as well as the issues faced by the country’s banking system have led to our reduced exposure. The high proportion of non-performing loans in Italian banks balance sheets points to the need for a recapitalization (around €25/30bn for the whole sector). In Spain, although the parliament remains divided post elections, the formation of a right-wing minority government seems possible. Furthermore, economically, Spain continues to appear in better shape relative to Italy. Growth dynamics remain sharper (GDP growth: 2.8% in 2016 and 2.5% in 2017 vs. 1.4% then 1.3% in Italy), highlighted by recent PMI data (54.9 for Spain versus 51.9 for Italy).

We therefore maintained our overweight on Spain (+0.2 CTMD) relative to Italy (-0.1 CTMD), driven by the evolving political dynamics and concerns about the Italian banking sector.

Core Euro countries: limited value at the front end

 The ECB’s very accommodative monetary policy is very supportive for core European yields. Furthermore, PSPP is driving sovereign yields further downwards, with more than 50% of the European bond market trading in negative territory, principally in core countries. Over the course of the month, core yields declined further towards even lower levels (GER 10Y at -0.09%, FR 10Y at 0.18%). Additionally, investor positioning on core sovereigns appears to have increased.

In this context, our framework continues to point to the relative expensiveness of core markets. Yields could nevertheless remain supported over the summer as negative flow dynamics will be very supportive, certainly when adjusted for PSPP. We are nevertheless keeping a tactical short duration bias via the German 2-year segment, as with a yield of -0.66% there remains limited value.

Currency strategy

Since the beginning of the year, the Brazilian Real (BRL, +17.8%) and the Japanese Yen (JPY, +12.6%) have been the top performers vs. EUR, while the British Pound (GBP, -12.5%) and the Mexican Peso (MXN, -11.2%) remain at the bottom of the rankings tables as this year’s worst performers. The GBP was massively sold after the Brexit referendum, though declines decelerated over the past month. Similarly, the Mexican peso, which had declined on the back of the anti-immigration stance of Donald Trump, saw some positive performance over the past month as oil prices stabilized.

Maintain a Neutral stance on most G10 currencies

Despite its safe-haven status and an increased probability of a rise in rates by the end of the year on the back of relatively hawkish rhetoric from Fed members during the Jackson Hole conference, we are sticking to our neutral position on the US Dollar vs Euro. The long-term indicators in particular (trade & capital flows, purchasing power parity) are pointing towards an overvaluation of the USD. There is also evidence of some unwinding of the heavy long positions on the greenback, which could also contribute to some weakness. 

The EUR still remains undervalued vs. all major G10 currencies and has kept a positive grade in our framework, thanks to the purchasing power parity indicator. With the ECB having disappointed markets on its expected accommodative stance, and currently ignoring calls for extension/expansion of the QE program, the Euro does appear to be supported. Furthermore, short positions on the EUR are not an overcrowded trade anymore, bringing the market positioning from short to neutral.

While we still do not have a strong conviction on the GBP, we feel there is a possibility for short term rebound in the currency. Despite the Brexit issue and the uncertainty that it implies, there has not been a sharp deceleration in the UK activity cycle. Additionally, the reflationary phase appears to be well entrenched. With a monetary cycle that we deem appropriate, and a currency that has witnessed sharp declines, we feel that there is some room for rebound. In this context, we aim to take tactical (albeit limited) positions on the Pound Sterling vs. the Dollar and the Euro

EM FX valuations are attractive on average and external risks (namely the slowdown in China, fall in commodities and a potential Fed rate hike) have subsided.

Hence, we maintain our overweight on the Argentinian peso (ARS), which benefit from the strong capital flows this year thanks to accelerating investments and well-received sovereign debt issuance. Additionally, we believe there will be a recovery in growth next year, providing further support to the currency. We also hold an overweight on the Brazilian real (BRL) following the impeachment of president Roussef and the appointment of a new government willing to implement fiscal reforms.

A more tactical overweight is placed on the Mexican peso (MXN) and the South African Rand (ZAR) on the back to stabilizing oil prices and relatively attractive valuations.

On the other hand, we are maintaining our structural underweight on Asian currencies. Due to the liberalization of its capital account and its slower growth, the Chinese Yuan (CNY) is experiencing a medium-term depreciation. The Thai baht (THB) is also entrenched in a depreciation stance amidst an accommodative monetary policy and deteriorating fundamentals.

Positive on the NOK, Negative NZD & AUD

Our framework is strongly positive on the NOK. Cyclical & FX frameworks are pointing towards a re-appreciation of the krona, especially since oil has formed a bottom. Conversely, we remain neutral on the SEK, even if long-term drivers are positive, as the inflation outlook is not offering signs of policy normalization.

NZD and AUD appear overvalued and long-term drivers suggest more downside for the AUD than for the NZD. The Australian activity cycle could support a FX appreciation while FX fundamental drivers (PPP, current account) remain negative.

 


Emerging markets: Overweight Latin America FX vs. Underweight Asian Currencies

Emerging market currencies are still highly sensitive to external risks and global growth. The sharp oil price decline since mid-July and the weak Q2 US growth data have re-introduced headwinds for emerging markets FX in the near term. We expect a structurally better environment for EM FX only when EM growth recovers decisively. EM FX valuations are attractive on average and external risks (namely the slowdown in China, fall in commodities and a potential Fed rate hike) have subsided.

Hence, we maintain our overweight on the Argentinian peso (ARS), which benefit from the strong capital flows this year thanks to accelerating investments and well-received sovereign debt issuance. Additionally, we believe there will be a recovery in growth next year, providing further support to the currency. We also hold an overweight on the Brazilian real (BRL) following the impeachment of president Roussef and the appointment of a new government willing to implement fiscal reforms.

A more tactical overweight is placed on the Mexican peso (MXN) and the South African Rand (ZAR) on the back to stabilizing oil prices and relatively attractive valuations.

On the other hand, we are maintaining our structural underweight on Asian currencies. Due to the liberalization of its capital account and its slower growth, the Chinese Yuan (CNY) is experiencing a medium-term depreciation. The Thai baht (THB) is also entrenched in a depreciation stance amidst an accommodative monetary policy and deteriorating fundamentals.

Quelle: BondWorld.ch