El boom y la caída que se avecina en renta fija

Chris Iggo, CIO de renta fija de AXA IM. - Lunes, 09 de Enero

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The coming boom and bust “We expect bond yields to continue to rise in early 2017. Primarily we see this as a rate adjustment reflecting the potential for fiscal stimulus and higher interest rates in the US. 10-year US Treasury yields should rise towards 3% next year. The Federal Reserve (Fed) is expected to raise rates at least twice this year. “European yields could be dragged higher but the European Central Bank (ECB) will keep on buying and the European growth outlook is still disappointing. Political uncertainty could impact on peripheral spread volatility.

“Credit markets’ relatively stronger performance should continue for some time even if total returns will be low. The tipping point of higher rates dampening the economic outlook and being negative for credit is still some way off.

“The default outlook remains supportive for high yield and the outlook for US sub-investment grade bonds is positive.

“The picture is mixed for emerging markets. In the short term we see the improvement in growth being more important (rising commodity prices and increased trade) but a strong dollar and higher Treasury yields need to be watched. We remain particularly positive on emerging market hard currency credit.

“Our core scenario is for higher yields in the first phase of the Trump era, associated with stable or narrower credit spreads, but followed by a widening of credit on any signs of growth slowing down. This is likely to be more of a rate bears market than we have seen for some time, but still the headwinds of low inflation, demographics and weak balance sheets will mean 2017 will provide some opportunity to buy duration.”

 

Trumping the markets

Rates – “The Trump boom is the current narrative, driving government bond yields higher. Following the December rate hike by the Fed, we expect to see further monetary tightening in 2017. We see two hikes this year, with the risk being to the upside. For European core rates, the fact that the ECB is slowly moving to tapering together with a tighter Fed should mean higher core rates. Our forecast for Q1 is for US Treasury yields above 2.5% and Bund yields as high as 0.7%. The risk to yields is also to the upside. Gilt yields are expected to reach 1.70%.”

Inflation – “Inflation was rising even before the US election, driven by base effects from the turnaround in oil prices. The recent OPEC deal together with a tightening labour market in the US will push inflation higher. We are positive on inflation linked bonds as break-evens remain below central bank medium term targets.”

European peripherals – “A higher yield environment without any pick-up in growth is negative for peripherals because of the high debt/GDP ratios in southern Europe. The Italian banking situation is a further reason to be cautious as is the political outlook in Europe. We will be more tactical where peripherals are concerned but strategically are less positive than in the past three years.”

Investment grade credit – “Fundamentals remain positive and stronger global growth should support spreads. Typically spreads narrow as yields rise as long as there is positive growth momentum. As such we see investment grade credit outperforming government bonds. The US is attractive from a yield point of view although flows will be determined by the cost of dollar hedging.”

High yield credit – “The equity like characteristic of high yield spreads should be positively influenced by better US growth. Fundamentals remain supportive and the lower duration of high yield markets make it an attractive asset class as long as growth remains positive. European high yield will continue to see some support from ECB policy but US returns are expected to be higher.”

Structured credit – “Valuations have become richer, but there are many opportunities to enhance yield with structured credit products. Loan spreads trade at a significant premium to high yield bonds and the demand for collateralised loan obligations (CLOs) remains extremely strong. We don’t see any credit issues disrupting the structured market.”

Emerging markets – “We are modestly cautious on the back of a better macro outlook. However, higher US yields and a stronger dollar are concerns. Markets are more robust than they were in 2014.”

 

Macro themes - An end to secular stagnation

US – “Any forecast for the macro outlook in 2017 has to be tempered by the recognition that much depends on what policies the President-elect Trump can enact in the first few months of his term in office. We expect some tax cuts and increases in Federal spending to add around 0.4% to GDP in 2017 and 1.2% to the baseline forecast for 2018. Given that the US economy is operating with an unemployment rate of less than 5%, the risk is that inflationary pressures build in the US. Fiscal stimulus should be positive for growth but we need to also keep in mind the negative impact of higher inflation on real incomes and any potential hit to business confidence from Trump’s foreign trade stance.

“Prior to the election the view was that monetary policy, globally, was becoming less effective in delivering better growth and inflation and that, at best, central banks would need to keep interest rates very low for a long time. That remains the case for Europe and Japan but the picture has potentially changed for the US. The Fed’s own forecasts for interest rates were already more bearish than the markets’ so there remains potential for expectations on future rates to be revised higher. At least there is a wider range of outcomes for interest rates, meaning a steeper yield curve in the US. We expect the Fed Funds rate to be at least 1.25% by the end of 2017, with risks to the upside.”

Global – “Although the global output gap continues to slowly close, the OECD estimates that it is still some 1% of GDP. This is likely to put a cap on how quickly inflationary pressures can build globally. Nevertheless, base effects and the impact of rising oil prices will lift inflation across the developed economies. Further significant easing by either the European Central Bank or the Bank of Japan (BoJ) is, therefore, unlikely. This works against bond yields testing new lows. It remains to be seen how much of a growth impulse the rest of the world can get from what is happening in the US but we are careful not to underestimate this.”

Europe – “The ECB was careful not to describe the changes to its quantitative easing (QE) programme as ‘tapering’. The decision to reduce the monthly purchases of bonds to €60bn from April means they can extend buying until the end of 2017 without creating issues of bond shortages. However, the market is forward looking as it sees the ECB having to wind down the programme towards the end of next year. Current economic forecast is for no change in the growth outlook for the euro area and for only a modest increase in inflation. This means policy rates remain very low beyond 2017 even if QE is wound down. For bond markets this translates into a steeper yield curve with benchmark Bund yields rising above 1.0% at some point in 2017.”

 

European political risks

“President Draghi has at least bought some time with his refusal to admit tapering. However, the political agenda is daunting, especially in light of the votes against centrist elites seen in 2016. Any evidence from the French, Dutch or German elections that the electorate in Europe has lost support for the European Union could increase risk premiums on peripheral borrowers. It is worth noting that the Italian-German bond spread has generally been moving higher in recent months and risk-spikes are taking the spread higher each time. With the recent collapse of the Renzi government and no wholesale resolution to the Italian banking crisis in sight, we would expect some periodic bouts of sovereign risk aversion within Europe.

“In addition, Q1 2017 will provide some movement on the Brexit issue with the UK government pledging to trigger Article 50 before the end of March. Any sign that the EU will not agree to a hard ‘soft Brexit’ could impact on credit spreads in both euro and sterling markets. The UK government was able to provide some modest fiscal help for the economy but this is likely to be overwhelmed by any deterioration in business and consumer confidence related to disappointment on issues such as access to the single market. Rising inflation in the UK is also a negative in the absence of wage growth, such that we have a negative macro outlook for the UK which is likely to keep sterling weak and could at some point lead to further easing by the Bank of England.”

Japan – “The Bank of Japan’s yield curve targeting policy is being seen in some quarters as more or less central bank financing of fiscal policy. Theoretically there is no constraint on the government in Tokyo financing fiscal stimulus through borrowing as the BoJ has pledged to keep 10-year yields at 0%. For fixed income markets this means Japanese investor flows will remain important drivers of global bond yields, depending on what happens to the cost of foreign exchange (FX) hedging. For Japan itself, forecasters see slightly better growth and inflation in 2017.”

World trade trends – “Oil prices are some 60% higher than the lows reached in Q1 2016 and this has certainly been beneficial to certain emerging market producers (Russia and Brazil for example). Other commodity prices have risen since the US election. These trends are positive for emerging markets and, in aggregate, we expect stronger GDP growth in 2017 led by recoveries in some of the major countries that suffered a recession in recent years. It remains to be seen what Trump does on the trade front in general and towards Mexico and China in particular. On that point, Chinese growth and trade numbers have been trending more positively in recent months and this is generally a supportive picture for emerging markets. After falling into negative territory in 2013-2014, world export growth is starting to rise. Alongside buoyant purchasing manager surveys, Q1 2017 should have a positive tone to it.”

 

FX market - Dollar strength ultimately a risk to market stability

US dollar – “The prospect of fiscal stimulus and higher interest rates is supportive for the US dollar. It has certainly strengthened further since the election and the path of least resistance is for further gains. Certainly, US assets will be attractive to yield starved investors in Europe and Asia and there is also the prospect of dollars held overseas being repatriated to the US. Not only could this add to further dollar strength but it may increase the cost of hedging for foreign investors into the US. This is already on the rise as a result of the widening of the interest rate differentials between the US dollar and other currencies. Any acceleration of flows into the US dollar could put upward pressure on funding costs outside of the US.

“The corporate bond spread between the US and Europe is currently 230bps for 5-7 year maturities. Hedging the FX risk for 1-year costs about 180bps. Further increases in US rates will erode the yield advantage for US markets further unless this is also associated with a steeper yield curve or wider spreads. However, we do expect to see continued significant inflows to US assets reflecting the US reflation theme.

“Higher Fed rates will support the dollar. However, a strong dollar does represent a tightening of financial conditions which will be an ingredient into the medium term slowdown in the US economy.”

Impact on inflation – “The other side of dollar strength is weakness in the euro, sterling and the yen. This should help promote higher inflation and, in some cases, be beneficial to exporters. However, rising import prices driven by commodity and FX moves will hit consumers and could delay further recovery in consumer spending. Emerging market currencies have recovered in recent months but remain much weaker than 2014 levels against the dollar. Further significant recovery is not likely in the months ahead and we are negative on emerging market FX exposure in general. Any sign of protectionist policies coming from Washington could lead to another bout of emerging market currency weakness if it triggers a reversal of more positive capital inflows seen in recent months.”

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