Fixed Income

Today marked the arrival of a long expected event, namely the inversion of the US yield curve between two and 10 years. This is an important event as historically it has been a very reliable indicator of impending recession. History tells us that once the 2s-10s curve inverts, on average a recession is a year to 18 months away.

Since the two anti-establishment parties (The League and Five-Star) formed a coalition and took control in Italy, markets have been uncertain on the domestic government policy that was promising many things to many people and ultimately creating considerable friction with the European Commission (EC).

The embers of the European ABS H1 primary pipeline are now cooling down for the summer break. After a slow start to the year driven by the delayed implementation of new regulations, we saw an increasingly busy pipeline as Q2 developed and became the third busiest quarter of issuance post crisis. July saw almost €20bn equiv. of supply, taking the year to date total to €58bn including a record €19bn in CLOs. This accords with our somewhat contrarian view that 2019 issuance would eventually keep pace with 2018 (a post crisis record). July’s total went a long way in achieving this, bringing YTD issuance just 6% short of the 2018 run rate. In late June this was 28%.

August has been a very challenging month so far for risk markets, while in traditional risk off, UST treasuries have seen sharp declines in yield back to the lows last seen in October 2016. We can’t help but think that this sharp adjustment will become more ingrained in August, following 6 months of relatively benign markets.

It was a dramatic night last night as the Fed cut interest rates by 25bps, the first cut since December 2008, along with the premature ending to the balance sheet run off – however markets hardly moved!

Over the past few weeks there has been a noticeable increase in high yield new issuance, bringing a welcome flurry of activity to what has so far been a relatively benign year.

The euro area bank lending survey for the second quarter of 2019, released yesterday, suggests European banks are becoming more cautious and beginning to tighten lending criteria to various parts of the economy.

The UK’s political situation, and in particular the harder Brexit stance of the frontrunner for next prime minister, Boris Johnson, has provided the market with a steady stream of headlines over the past few weeks. As a direct consequence sterling is close to 6% off recent highs and domestic credit spreads have also underperformed their European and US peers.

One of the market’s chief obsessions in 2019 has understandably been the shifting stance of the US Federal Reserve in relation to the path for interest rates, with investors now pricing in a 100% chance of a rate cut at the end of this month. Now that the June FOMC minutes, Nonfarm payrolls, Jerome Powell’s testimony to Congress, the June CPI and PPI numbers and the Trump-Xi meeting at the G20 in Osaka are behind us, what is the next set of data that may shed some light on the Fed’s next policy move?

Yesterday we heard from US Federal Reserve Chairman, Jerome Powell, as he testified at the House Committee on Financial Services. Obviously the main focus for markets was to glean any additional information regarding the future timing and path of the Fed Funds rate. However, as important for fixed income investors as the future path for rates is, listening carefully to central bankers can also provide insight into the bigger picture economic environment. My ears pricked up in particular at two important and related topics Mr Powell discussed.

European bond markets can breathe a sigh of relief this morning as Christine Lagarde is poised to be the new president of the European Central Bank, succeeding Mario Draghi in October.

As we approach the end of Q2, a time when the price of currency hedging can typically spike, we have been reviewing the likely changes in the so-called ‘costs’ of currency hedging. I use the term so-called as these are not really costs, merely a differential in short term interest rates, which for some investors can be a gain and for others it will be a reduction in the yield or return of an asset.