Global Weekly: Bonds – choppy markets

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After a choppy beginning of August, with the volatility index VIX hitting 24.6 (the highest level since 3 January 2019), markets seemed to have found some relative stability. One of the factors contributing to this stabilisation was the recent decision by the Trump administration to postpone until 15 December the latest tariff increase in the ongoing trade war with China. However, the market’s positive response to this news could be short-lived in an environment of weakening global growth. The looming economic slowdown was once again highlighted this week with Germany’s GDP contracting by 0.1% in the second quarter of 2019 (quarter-on-quarter), down from +0.4% in the first three months of this year. The disappointing growth data did not affect the 10-year German Bund, which remains a safe haven in a volatile market environment. Bund yields, moving inversely to prices, hit an all-time low at -0.641%.

Looking at US Treasuries, we expect ‘once again’ to be a central theme in financial media in the coming days, after the US Treasury 2-year/10-year yield curve inverted this week. Yield curve inversions, where longer-term yields fall below shorter-term yields, are considered to be signals for a recession period. As a matter of fact, a 2-year/10-year yield curve inversion has been a prelude to the last seven recessions. The last recorded inversion of this part of the yield curve occurred in December 2005, two years before the financial crisis and subsequent recession. This signal should not be taken lightly but, as evidenced by the previous curve inversion, it could still take some time before a recession would actually occur.

In emerging markets, Argentinian markets tumbled following primary election results largely supporting the centre-left candidate Fernandez against the sitting centre-right president Macri. This unexpected clean-cut outcome was perceived as unfavourable by financial markets. We consider the contagion risk for other countries as very limited and we expect the current panic to be followed by some stabilisation in the coming weeks.

In this unpredictable political context (trade war, possibly a ‘hard’ Brexit, anticipated elections in Italy) and with the global economy slowing down, we still believe in the power of central bank intervention: by keeping interest rates low, central banks can help to prolong the economic cycle. We are therefore sticking to our current duration overweight position (duration: a measure of interest rate sensitivity) with longer-maturity bonds potentially outperforming bonds with short maturities. In the high return strategy, we keep our preference for emerging market debt (EMD) over high yield. The dovish decisions of the Fed are favourable for our EMD position, which could get even further support if the US dollar were to weaken. High yield, in our view, remains expensive with limited upside (in euro’s or dollars) in the medium-term.

Equities – a bumpy ride

Equity markets declined this week, but it was a bumpy ride with large intraday fluctuations caused by macro and political news. Markets were off to a positive start on Monday, as the yuan recovered. The recovery of the Chinese currency signalled that China’s central bank wants to manage an orderly depreciation, after last week’s yuan weakening caused market turmoil. However, market sentiment turned negative due to protests in Hongkong. On Tuesday, after Trump announced to delay the announced 10% tariff on some Chinese imports until mid-December, equity markets recovered.

Markets declined again on Wednesday, due to disappointing macro-economic data from China and Germany. Chinese retail sales and industrial output missed estimates. Data showed that Germany’s economy contracted in the second quarter. This, in combination with a report released on Tuesday indicating that German investor confidence has deteriorated, raised fears for a recession in Germany. 

Chinese online giant Tencent published its second-quarter results on Wednesday. Revenues missed analysts’ estimates, while profits came in better than expected. The advertising segment showed lower growth. There is more competition in this segment and companies in several sectors are reducing their advertising budgets. Tencent expects that challenges in the advertising segment will continue during the rest of the year. Meanwhile, Tencent’s gaming business, its largest division, performed better during the second quarter than in the same period last year. At the end of last year, Tencent had problems getting permission from authorities to launch new games. In the second quarter, this situation improved significantly. As a result, much more games were launched in the second quarter, although still less than before the problems with the authorities started. The company’s stock fell after the publication of its results.

Cisco, provider of hardware and software solutions for online networking, published results for its fiscal fourth quarter. Results were in line with expectations, but the company lowered its guidance for the next quarter. Cisco also signalled disappointing sales in China and noted it is no longer being invited to bid on new contracts in China. The Chinese business is just a small part of Cisco’s business.