DPAM Blog

VALUATIONS

• • The US yield curve continued on its gentle bull-flattening path. 2 year notes went up by 2 basis points (bp), finishing at 22bp, whereas 10 year rates dropped 4bp to 60bp. Meanwhile, 30 year rates shed 9bp to 1.17%. The Fed announced a lowering of its daily purchases from USD 15 billion to USD 10 billion. The news passed without any curve impact. Inflation-linked bonds (i.e. US TIPS) staged a notable comeback with break-even rates (inflation expectations) rising by 10-15bp. This then pushed US real yields deeper into negative territory. Market participants have gotten comfortable with the implicit yield curve control. With the US Fed at the effective lower bound, all developed market (DM) central banks have reached 0% or negative policy rates. This turns on the appetite for duration. Quantitative easing programs (automatic duration absorption) and a global search for quality yield might dampen steepening pressures. We repeat our neutral duration stance on US bond markets.

• • German 10 year rates were flat this week and closed at -48bp. The rollercoaster on 10 year Italian rates surprised with another steep ascent to 2.15% followed by a steep return to near-start-of-the-week levels of 1.83% by Friday. Spanish and Portuguese government paper saw rates regress as supply was absorbed. The Spanish debt office issued a record breaking EUR 15 billion in the 10 year sector. Both markets recovered well by Friday. After market close, the S&P surprisingly held onto its BBB rating (negative outlook) for Italian Government debt. The external cause of the worsening debt ratios (i.e. the corona health-crisis) was their main reason for not downgrading the government debt. We expect a positive read-through on Monday morning. This might also stop Moody’s from downgrading Italian government debt on May 4, or Fitch from doing so on July 10.

• • Demand for high quality EUR IG corporate bonds is rampant. This week saw aggressive purchases across credit curves, including 15y to 30y maturities. The EUR Iboxx corporate index finished the week with a -3.62% return YtD. This represents a solid 50% recovery from the March 25 bottom of -7.28%. Index spreads roughly stuck to the 200bp mark, with an index yield of around 1.46%. Primary markets were thin. We expect higher new issuance from May onwards as the result season progresses. US IG credit saw reduced positive traction, as the impact of the primary and secondary FED corporate funding programs did not turn into front-running behaviour. We repeat that the ECB’s CSPP is significantly more potent, as it is direct and of high impact to longer-term funding conditions. Interestingly, Money Market funds that can invest in bonds seek to profit from attractive spread levels adding bonds expiring within 12 months. In general terms, we might expect continued high demand for (quality) EUR IG credit in the 2 year to 7 year sector, as investors still seek to lock-in yield levels between 0.5% and 1.50%. Again, it is pretty clear that all DM central banks have adopted zero or negative policy interest rates for the next 2 to 3 years at least.

• • EUR HY credit took a pause last week. Idiosyncratic risk was abundantly present. Hertz and Avis HY bonds reached new lows and sank towards deeper levels of distress. EUR HY index spreads increased towards 650bp, and yielded 6.00%. In the US, HY spreads rose to 760bp, with a 8.3% yield. As in previous defaults cycles, it will be ‘Missed interest payments’ that will drive restructuring and default events. HY companies might have enough near-term liquidity and reasonably scheduled debt maturities over the coming years. Yet, as company management faces an unsustainable, over-leveraged capital structure, it is pushed to restructure. The magnitude of the current cyclical shock will effectively force management into restructuring or, at worst, defaulting. Non-essential businesses in sectors like retail, autos/rentals (besides gaming), leisure and lodging might get hit heavily as social distancing becomes the norm.

• • Emerging bond markets further consolidated last week. Local Currency spreads (GBI-EM) tightened by 10bp, to 435bp. In hard currency, spreads were slightly higher. Hard Currency IG traded at 350bp (+5bp). Broad Hard Currency (EMBIG) widened by 25bp (to 640bp) and Sub-Saharan Africa spreads in Hard Currency widened by 50bp (to 950bp). Despite a weak EM currency environment, local currency is outperforming hard currency YTD in total returns.

• EM currencies has had very mixed weekly performances.

• Asian currencies performed well (Indonesian Rupiah (+2.0%), Thai Baht [+1.6%], Indian Rupee [+1.5%] in EUR terms), but Latin American currencies underperformed (Brazilian Real [-7.5%], Mexican Peso [-2.8%], Colombian Peso [-1.7%] in EUR terms).

• Peruvian Sol was an exception in the region (+1.7%). Pensioners in Peru were allowed to withdraw money from their pension schemes. The liquidation of (mostly foreign) assets by the pension funds, was supportive for the Sol.

• • Bondholders did not welcome the restructuring offer made by Argentina. The blue chip swaps (i.e. the exchange rate at which foreigners can repatriate local currency holdings) are now at a discount of 85% compared to the official Peso exchange rate.

  • In Brazil, the popular Justice minister Sergio Moro has clashed with President Jair Bolsonaro over the president’s push to replace the head of Brazil’s federal police. This has caused an 80bp bond sell-off. High uncertainty is expected to keep Brazilian risk premia elevated.

  • In Sub Saharan Africa, investors mainly wonder how the countries will be able to combine both COVID-19 related spending and external debt payments.