DPAM Blog

VALUATIONS

• • I was word counting for about 25 minutes into the Fed’s press conference, when I folded and decided to call it another day in the market. Inflation was beating labour handsomely as market watchers kept on asking the same questions relating to the high inflation prints over past weeks. Tiring. Yet, the messages Powell was giving were pointing to the importance of labour market health mainly achieved through a higher participation rate and improving labour conditions. Reaching for nuance and objectivity in narratives, that are created under pump and circumstance in TV studios broadcasted 7 by 7 across the world, is a near impossible feat. However, the market is always right. The messages above are testament. The labour repair over the next couple of months will set the tone in rate markets.

• • The recovery in European Government Bond markets hit a brick wall retreating 38bp closing at -3.18% year-to-date. The US yield curve bull flattening filtered through core EMU rate markets. The long end of the German curve adjusted by about 3.5bp, closing at 0.25%. German 30-year rates made a high on May 18 at 0.46%. What strikes is the aggressive flattening of the 10-year to 30-year German rate differential, suppressing by 10bp towards 45bp. A highly unusual movement to say the least. Italian, Spanish and Portuguese government bonds lagged an overall-supportive week for core rates. We welcomed the inaugural 10-year 0% coupon Next Generation EU bond. It got issued at 0.08% (called the re-offer rate) obtaining the label ‘attractive’ when compared to the German curve. The first EUR 20 billion broke well into secondary markets and everyone is looking forward to end-of-month new issuance. The only negative was that about eight market-making European and US financial institutions were disallowed from participating in the syndication. Reasons related to penalties struck over rates rigging over the past decade. At a time when liquidity has become a key risk factor in financial markets, it appears an odd decision as the banks in question paid litigation amounts and addressed governance issues.

• • European investment grade (IG) credit and high yield (HY) credit encountered stiff resistance and could not hold onto any gains over the week. The IG corporate bond sector lost 11bp, versus a modest 13bp retreat in HY. All eyes are set on global equity markets that featured an appalling close. As most of the summer optimism has been priced across sectors, one wonders how the credit risk premium will fare the moment US taper discussions intensify, or the shadows of the pandemic become longer.

• • The impact of the Fed’s hawkish tilt has been felt in USD returns as the strength of the US Dollar weighted on EMFX. The index for local bonds (JPM GBI EM GD) lost -1.90% in USD terms when returns were flat in EUR. The yield of the index increased by 6bps to 4.98%, while the spread of the index in hard currency (JPM EMBI GD) increased by 2bps to 336bps versus US Treasuries. The bulk of the spread widening has been felt in lower-quality names with the spread of sub-Saharan Africa increasing by 10bps during the week.

• • The bull run in Copper that started one year ago is showing some signs of fatigue. Copper went down 6% in one week and news flow was negative, with increasing focus from Chinese authorities on the price of metals. The National Food and Strategic Reserves Administration announced to release some copper, aluminium and zinc, making them available to manufacturers. State-owned enterprises were also ordered to control risks and limit exposure to commodities markets. They have been asked to report their futures positions to the authorities for review, in order to curb speculation in commodities markets.

• • Kenya raised USD 1 billion in a Eurobond sale. The book received more than USD 5 billion of firm interest for a 12-year bond yielding 6.30%. While it priced tight versus secondary (2032s were yielding 6.25%), the deal performed nonetheless on the secondary market in a similar fashion to the recent new Senegal issue in EUR, showing the strong appetite from investors for low-rated paper. While Kenya is expected to borrow around USD 7 billion in the Eurobond market over the next two years, the government stuck to the target amount despite oversubscription.

• • Costa Rica’s (rank 10/70 in our ESG ranking) economic, social and environmental progress is an example for the whole Central American region. Its fiscal situation remains however a critical vulnerability, as large deficits (fiscal balance -7.00% of GDP in 2019 and -9.1% of GDP in 2020) threaten these remarkable achievements. Improving public spending is a top priority, as public salaries are almost 50% higher than in the private sector and compensation of government employees accounts for more than half of total government revenues. The approval of the public employment bill in the first of two required votes this week, is part of the initiatives proposed by the government to adjust its finances in search for an agreement with the IMF on a USD 1.8 billion IMF program. The bill creates a new single framework for employment in the public sector and is now sent to the constitutional court for a 30-day review prior to a final second vote. The extremely slow legislative process in Costa Rica, has resulted in missed deadlines in the past. Whether the deputies respect IMF deadlines is a bigger hurdle than political support for the bill itself.

• • In South Africa, President Ramaphosa seems to be firming his grip on power and accelerating its reform drive. After mostly incremental reforms, two recent announcements are showing the government is having the upper hand on internal dissenters within the ANC to push for some flagship reforms. First, the President announced the lifting on a cap for embedded electric generation from 1MW to 100MW, in order to address the energy supply shortfall and the risk of load shedding that is weighing on growth potential. This is a surprise, given the fact the private sector had been lobbying for 50MW and the Minister of Mineral Resources and Energy had previously announced 10MW only, calling the 50MW cap some “noise”. Following the President’s announcement, the Minister swiftly announced it would also work with Eskom to “rapidly bring to fruition at least 1.6GW of largely renewable and private-sector funded generation projects”. Second, Minister of Public Enterprises Gordhan announced the government would sell a 51% stake in bankrupt South African Airways to a consortium made up of a private equity firm and an aircraft leasing company. The Minister had previously stated it would retain the majority control of the airline, which was a major constraint for any potential private investor. Whether this is the start of a new approach in which the government does not guard a controlling stake in its state-owned companies (over 700) is not clear yet, but it seems a taboo has finally been broken.