DPAM Blog

VALUATIONS

• • The inaugural 20-year US Treasury auction was very successful on May 20. The new bond was auctioned at a yield of 1.22% and closed the week at 1.12%. Strikingly,10-year and 30-year rates backed up marginally by 1.5 basis point (bp) and 3 bp to close at 0.66% and 1.37% respectively. There was some nervousness about potential negative interest rate policies, but we remain firm on that matter and attach almost 0% probability that the Fed will pull its Funds Rate below 0%.

• • German 10-year rates inched up to -49 bp. Year-to-date, on average, 10-year bunds have traded at -44 bp. Clearly, the action was found in promising EMU government bond rate convergence. The catalyst was the Merkel-Macron breakthrough agreement-in-principle on the European Recovery Fund structure. The Fund might be an initial step to allow an EU institution like the European Commission to issue bonds backed by increased EU budget contributions. This would be evidence of solidarity, since funds would be redistributed as grants to the EU regions most heavily impacted by Covid-19. Details should be finalized at the June 18-19 EU summit. Already Holland, Austria, Denmark and Sweden have voiced their discontent. Then again, markets did not wait and kick-started a rate convergence move following this historic event. What the ECB could not accomplish on its own was achieved through common sense EU politics. Spanish 10-year rates dropped 13 bp to 0.62%, closely followed by Portuguese 10-year rates finishing 15 bp lower at 0.72%. Italian government bonds (BTPs) profited most. Ten-year Italian rates dropped 27 bp to 1.59%. The closely monitored bund-BTP spread closed at 218 bp. The Recovery Fund negotiations will only be labelled a success if the EU can tap the structure in the future. A positive long-term outcome might see a tightening of spreads to bunds of 10 bp to 50 bp over the summer for, respectively, European semi-core and periphery government bonds. However, if the Recovery Fund’s only use is to cushion the impact of the Covid-19 crisis, markets might quickly do an about-face regarding rate convergence. A new EU debt crisis might lurk around the corner. Yes, there’s a fine line between love and hate in the European government bond universe.

• • EUR investment grade (IG) corporate bonds recovered nicely. Over the past week, the EUR Iboxx corporate bond index gained 45 bp. Year-to-date, the decline narrowed to 3.25%. EUR IG corporates might draw increasing interest again on the back of “recovering” EMU government bonds. Primary issuance in EUR and USD IG corporates will hit record levels over 2020. This attracts demand. With developed market central banks expected to keep policy rates at 0% for years to come, the appeal of IG corporates should remain steady.

• • EUR high yield (HY) bonds posted their third best weekly performance since the March crash, adding 1.79%. As a result, their year-to-date decline was reduced to 8.98%. We do expect more companies to drop out of the IG universe to enter the HY universe. This will keep an IG/HY spread decompression in place over the remainder of 2020. On balance, we expect HY performance to be less resilient than IG performance.

• • Emerging market debt had another positive week, with local currency spreads (GBI-EM) tightening another 10 bp to 400 bp. In hard currency, spreads tightened even more. Hard currency IG debt traded at 300 bp (-30 bp). Broad hard currency (EMBIG) tightened by 50 bp to 550 bp and Sub-Saharan Africa spreads in hard currency tightened by 80 bp to 805 bp.

• • Emerging market currencies had a very good week as well. Currencies that performed best were those that had recorded the weakest year-to-date performances so far. However, Asian currencies, which had performed relatively well year-to-date, underperformed last week. This is a good indicator of improving sentiment in emerging markets. The Brazilian Real (+6.0% in EUR terms), South African Rand (+4.7%), Mexican Peso (+4.6%) and Colombian Peso (+2.8%) were the best performing currencies last week. The Argentine Peso (-1.4% in EUR terms), Indian Rupee (-1.3%), Chinese Renminbi (-1.2%) and South Korean Won (-1.2%) were amongst the currencies that posted negative returns versus the EUR.

• • We believe that emerging markets will continue to do well in the coming weeks. We are keeping a close eye on China-US relations as they are a potential source of market stress. Also, Brazil’s President is coming under more pressure after the Supreme Court released a video of him threatening to remove Rio’s police chief. Meanwhile, the Argentine government announced last Thursday evening that it would delay its debt swap offer till June 2. In practice, this means that the government will fail to make a USD 503 million debt payment, thereby placing the South American country’s entire foreign debt in default.