Bond Outlook February 15th

In a week when the USD has strengthened, the US stock markets risen and consumer spending expanding, it is difficult to maintain the doubts we have over the fundamentals of the US economy, but maintain them we must. Just why American households, after trimming their sails in December, should let them out again in January is beyond simple explanation, although one comment put it down to mild weather! We rather suspect Christmas bonuses, combined with resolute refusal to take account the gathering clouds of a 6% and growing external deficit, low employment participation, the public and private reductions in health, education and welfare benefits, the pension crisis and the end of the housing bubble. Even farming subsidies are coming to an end, as the US military spending removes room for budgetary manoeuvre.

The world is in fear that a US slowdown will cause a global recession, and certainly the Chinese and other dollar-peg countries are acting on that fear in supporting the USD. Yet the move from a unipolar to a tripolar world, long evoked in our Weekly as an essential step towards global economic balance, is now well underway. Growing consumption in Asia and oil-rich countries will soften the impact of the forthcoming USA slowdown. Even Europe will help. The public sector strikes in Germany over longer working hours do not assist the incipient recovery there, but they may also be seen as the rearguard action of a declining force (echoes of the British miners’ strike). Even France has taken a step further back from its destructive 35-hour week with a new steelworkers’ agreement. It will be years before that bastion of French privilege, the public sector, comes round, but at least there is hope.

Global balancing is reinforcing a trend that we have already identified, bond issuance in emerging and transition economies in local currencies. The view of Walter Molano of BCP Securities strikes us as a little over the top, but worthy of note, especially in the context of the long-term implications of global economic rebalancing for the fixed-income market: “The reprofiling of foreign debt into local debt will eliminate balance of payment crises and it is only a matter of time until dollar-denominated eurobonds and globals disappear”.

Brazil is the prime example of a country that has “joined the world”. It is paying back its debt, opening up its financial markets, removing exchange controls and expanding steadily. For the moment settlement in BRL is still via the USD, but even this will change. Other currencies of growing importance for the bond market, but which can be settled direct, are: SGD, MXN, HUF, TRY, ISK, ZAR, THB and BWP (Botswana Pula for readers who do not immediately recognise the abbreviation!). There is also interest is EGP and INR, but neither the Egyptian nor bonds Indian can be settled internationally. Their time will come.

Obviously le grand absent is China. The day the RMB becomes a freely traded currency and its bonds gain international status, rebalancing will really be complete.

The narrowing of spreads on emerging market sovereign debt has been underway for many years, but has accelerated in recent months. For example, the JPMorgan USD index showed a spread over Treasuries of 300 bp six months ago, before a rapid fall to 250, and now to 200.

In the UK the rate of inflation has fallen below 2%, leading to speculation that the BoE will soon lower the bank rate. We would not be so sure, as it appears that, unlike the Fed, the BoE does look upon housing prices in deciding whether money needs loosening or tightening. House prices in the UK are again increasing, and we would not expect the BoE to want to reinflate the bubble. In addition, it would be strange for the UK to be lowering rates while the pressure is still upwards in the USA and Euroland.

Recommended average maturity for bonds in each currency

Stay with bar-belling for CHF and EUR.