Etikett: Bonds

Will Eurozone bonds go ‘back to the future’?

Will Eurozone bonds go ‘back to the future’? WisdomTreeHeadlines surrounding the Italian budget saga and sovereign debt ratings have certainly garnered their fair share of interest within the global bond markets. Interestingly, the heightened anxiety level has produced fears of another potential contagion event, as investors witnessed during the ‘Grexit’ 1 episode. Naturally, that has raised the question of whether Eurozone bond markets could experience a “back to the future” moment; in other words, reliving the past.

When contemplating the possibility of such a scenario developing, it is rather useful to examine how various Eurozone sovereign debt markets have behaved in this latest bout of uncertainty, more specifically looking at the countries that were full participants in the Grexit contagion event (Italy, Spain, Portugal and Ireland). These four nations were deemed the periphery countries of the Eurozone, and as the reader will recall, were at the centre of concern, not only if Greece elected to leave the Euro, but also due to their own respective fiscal/financial challenges at the time.

Figure 1: 10-year government bond yield spreads vs. German bunds

Source: Bloomberg, WisdomTree, 29 October 2018. Historical performance is not an indication of future performance and any investments may go down in value. Note: Ireland bond data was discontinued between 11 October 2011 15 March 2013.

The initial results are in, and thus far, the concerns raised regarding Italy have been confined to Italy and have not yet spread to the other three aforementioned countries. A valuable tool in discerning potential ‘contagion’ fears lies in the yield difference, or spread, between an asset that is viewed as being more of a safe-haven, such as the 10-year German Bund and the like maturity sovereign issues of the other countries in question. As figure 1 clearly reveals, this most recent bout of concern has stood in stark contrast to the Grexit experience. Indeed, the ‘Grexit experience’ really captures the issues that were confronting not just Greece, but the other four periphery countries as well and lasted from roughly mid-2010 to mid-2013 or so.

Let’s look at some the numbers or spread levels for perspective. The peak period of duress was captured between 2011 and 2012. At that time, Portugal experienced the most notable spread widening versus the bund, with the peak differential ballooning out +1560 basis points (bp) in January 2012. For Spain and Italy, the peak readings were +639bp and +553bp, respectively. So, where are we now? The Portugal 10-year spread stands at +150bp as of this writing, with Spain coming in a bit narrower at +117bp. On a year-to-date basis, both readings are essentially unchanged. Examining developments from a more recent context when the Italian budget and credit rating news started making front-page headlines in late September, the Spanish 10-year spread widened out only 19bp, while for Portugal the increase was also on the more modest side of 16bp. What about Italy? The Italian 10-year BTP/bunds spread has risen by almost +140bp year-to-date, and +65bp from late September.

Where do we go from here? The recent actions from both Moody’s and S&P ratings agencies seem to have lifted a veil of uncertainty on the Italian government bond market, at least for now. For the record, Moody’s did lower the actual rating for Italy a notch to Baa3, but shifted their outlook to ‘stable’. For S&P, the rating itself was left unchanged at BBB, however the outlook was downgraded to ‘negative’. In the immediate aftermath of the S&P announcement, the Italian 10-year yield fell 35bp from its most recent peak, with the BTP/bund spread narrowing 25bp.

Conclusion

Despite the fact the worst credit rating fears were not realized, the potential for continued negative headlines has not been removed. To be sure, S&P noted the Italian budget outlook will remain a key area of contention in their lowering of the sovereign outlook. The EU’s ‘negative opinion’ regarding Italy’s budget will more than likely be a saga that continues to play out. In fact, the recent disappointing print of zero growth in Q3 GDP quarter/quarter does not bode well on the budget front either. While contagion is always a risk if developments were to spiral downward from here, the lack of a clear-cut trend for the other periphery countries up to this point has been somewhat encouraging but stay tuned the outlook remains a volatile one.

All data from Bloomberg as of 29 October 2018.

1 Refers to Greece’s possible withdrawal from the Eurozone, which made frequent news headlines from 2012 to 2015.

By Kevin Flanagan

This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.

Don’t sell your long duration bonds

Don’t sell your long duration bonds

ETF Securities Fixed Income Research – Don’t sell your long duration bonds

Highlights

  • We expect a gradual flattening of the US Treasury yield curve, providing grounds for holding long duration bonds.
  • The major source of bond returns have come from coupons, not capital gains over the past seven years.
  • Greater bond portfolio convexity gives the best returns in a volatile interest rate environment.

Global yields are picking-up

Global yields have bounced back from extremely low levels as expectations intensify about major central banks unwinding quantitative easing and normalising monetary policy. The shifting tone from central bankers in the western developed world has been driving a two-week global sovereign bond rout. In June and early July, global government bond yields rose by 25bps on average.

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The CFTC futures data shows net short speculative positioning at the front-end and net long speculative positioning at the long-end of the US yield curve, suggesting that investors are not yet convinced that economic conditions are improving to a point that drastically changes the GDP and inflation outlook. Additionally, the net long positions on the 10-year US Treasury notes is extreme: it has reached levels last seen in 2007.

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The Fed’s previous monetary tightening cycles have coincided with low asset price volatility and a bear flattening of the Treasury yield curve (short-end yields rising at a faster rate than the long-end). The 10yr – 2yr Treasury yield spread has already collapsed by 190bps since the end of the financial crisis and volatility is extremely low.

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The gradual pace of interest rate increases should place greater upward pressure at the front-end of the yield curve relative to the long-end. We believe the subdued inflation outlook coupled with the structural demand for long-dated bonds will partly offset the upward pressures on the long-end caused by the unwind of quantitative easing policies and the normalisation of central banks’ balance sheets. Thus, we expect a gradual flattening of the yield curve, with relatively low impact on long duration bonds.

Duration compensation at all-time low

Duration is a measure of a bond’s sensitivity to changes in interest rates. While the maturity of a bond is directly related to duration, the coupon rates and interest rates are inversely related to duration. For example, a bond with a duration of 5 would expect to lose roughly 5% if interest rates rose by 1%. A zero-coupon bond has a duration that is equal to its remaining maturity, while a coupon bond has a duration shorter than its maturity.

Typically, the longer the maturity, the higher the duration and the higher the interest rate risk. Bonds with longer duration fall in value with an increase in yields, while shorter duration bonds rise in value with an increase in yields. The average duration of global bonds has expanded after the financial crisis partly due to issuers taking advantage of cheaper long-term financing conditions permitted by extremely accommodative monetary policies worldwide. As a result, the duration risk compensation declined alongside the long-term yields before stabilising at historically low levels.

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In a context of rising interest rates, investors generally shift toward shorter maturity bonds or higher coupon bonds in order to reduce the interest rate risk (i.e. duration) in their portfolios. The Fed’s monetary tightening is likely to affect short-, medium- and long-term rates differently, which represents a challenge for bonds investors wanting to adjust duration for rising interest rates. In general, shorter maturity bonds have lower sensitivity to an increase in rates but also have lower coupon returns than longer dated bonds and might not fully compensate for inflation.

However, coupon returns typically represent the main contributor to the bond total return while in comparison capital gains are negligible1, particularly for long-term investors for diversification and income. Overall, adjusting duration is a trade-off between lower capital risk and higher coupon return. Therefore, short duration strategies might underperform long duration strategies in a rising interest rate environment.

Convexity provides returns when volatility rises

Another way of hedging against interest rate risk is through portfolio immunisation strategies where the average bond portfolio’s duration equals investors’ investment horizon. In this strategy, any changes to interest rates will affect both the price and the reinvestment of the coupon payments at the same rate so that the rate of return is fixed over the investment period. Institutional investors, such as pension funds, use them extensively. However, this strategy can be costly as it needs frequent rebalancing.

In the example below, we illustrate that having long duration bonds in an immunised portfolio can actually increase returns despite interest rate fluctuations. We have built two hypothetical immunised portfolios of two bonds with the same credit quality but with different coupon rates, maturity and duration. The portfolio 1 includes two bonds with a duration of 4 and 6 years, while the portfolio 2 includes two bonds with a duration of 4 and 16 years.

Both portfolios have the same average duration of 5 years, which matches our investment horizon. We conducted a static analysis where only interest rates vary around their current level of 2% to see how our two portfolios behave. Our example shows that portfolio 2, which includes a longer duration bond, gives the best returns at any level of yields. In addition, the immunised portfolio with the greater convexity2 – as defined by the curvature of the relationship between the bond price and yield – gives the best return regardless of whether interest rates rise or fall.

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As we head into global monetary policy normalisation, interest rate volatility will likely increase which would justify holding bond portfolios with higher convexity.

For more information contact:

ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com

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Why Emerging Markets Bonds Offer More Than Just Higher Risk Premiums

Why Emerging Markets Bonds Offer More Than Just Higher Risk Premiums

Why Emerging Markets Bonds Offer More Than Just Higher Risk Premiums. It is time to think about a strategic allocation to emerging markets bonds, according to William Sokol, Product Manager at VanEck. Increasing strategic allocation to emerging markets bonds promises more benefits that just higher risk premiums. As the asset class continues to grow both in size and diversity, emerging markets bonds can boost income producing potential and provide unique diversification.

Low correlation offers unique diversification

“An analysis of the past ten years shows that emerging markets bonds generally exhibit moderate correlation to other core fixed income asset classes,” Sokol explains, “particularly when compared to U.S. equities.” While the correlation between U.S. high yield bonds and U.S. equities is 0.73, local currency emerging market bonds correlate only 0.62. Even U.S. dollar-denominated emerging market bonds exhibit only a correlation of 0.58 to U.S. equities. The correlation is slightly higher for emerging markets high yield bonds at 0.67. “The generally lower correlation of emerging markets bonds to U.S. equities can indicate a higher potential for diversification within an investor’s credit portfolio.”

Emerging markets bonds boost income producing potential

Besides the lower correlation and high yields, emerging markets bonds may boost the income producing potential of a portfolio. This is shown by the analysis of the weighted average yield to worst (YTW), the lowest potential yield that can be received on a bond without the issuer actually defaulting. Emerging markets corporate high yield bonds achieved the highest YTW of all fixed-income classes with 6.95 percent. To compare: The YTW of U.S. high yield bonds was 6.12 percent. With an YTW of 6.65 percent, emerging markets local sovereign bonds came in second.

 

ECB’s minutes reveal concerns over Eurozone bonds scarcity

ECB’s minutes reveal concerns over Eurozone bonds scarcity

ECB’s minutes reveal concerns over Eurozone bonds scarcity. The minutes of the ECB’s December meeting, published yesterday, revealed that the increasing scarcity of high quality government bonds such as German bunds, was at the centre of the two main decisions taken by the Governing Council. Overall, the ongoing deleveraging of the public and the private sectors, coupled with the ECB’s purchases and the elevated demand for high quality Eurozone government bonds have aggravated the shortage of supply. We believe that this is a warning signal that QE in its current form has reached its practical limit in Europe. While some Eurozone governments have procrastinated in using fiscal stimulus, they will soon no longer have the choice but to implement structural reforms to support the economic recovery. Consequently, we believe the rotation from monetary to fiscal stimulus has not been fully priced into the market yet. Thus, we expect Eurozone yield curves to gradually steepen in 2017. Regarding the extension of the Asset Purchase Programme (APP), the minutes revealed that Governors debated over two options: a 6-month extension at a constant monthly pace of EUR80bn and a 9-month extension at a slower pace of EUR60bn. While the first option would have resulted in a smaller total amount of additional purchases (EUR480bn against EUR540bn for the second option), liquidity-related challenges drove the discussion toward the latter option. The first option would have necessitated an additional modification of the parameters of the programme, namely a change in the capital key – the proportion of bonds the ECB can buy from each country defined as the capital participation of the country to the ECB balance sheet. The ECB’s APP has supported bond valuations and reduced the supply of high quality bonds, making government collateral more expensive, leading daily volumes and rates in the European repo market to decline. In order to reduce these unintended consequences on the repo market, the ECB provides a securities lending programme (SLP) where the holdings of securities purchased under the Public Sector Purchase Programme are available for securities lending. The minutes revealed that the relaxation of the conditions to borrow collateral from the SLP was primarily to address the increasing scarcity of high quality bonds and collateral. Accordingly, ECB’s Governors announced in December that cash would be accepted as collateral against securities (no longer exclusively high quality bonds). Despite the marginal revisions of the parameters of the QE to smooth its implementation, the ECB’s monetary stimulus seems close to its practical limit, suggesting the Eurozone yields have reached their floor.

Morgane Delledonne, Fixed Income Strategist at ETF Securities

Morgane Delledonne, Fixed Income Strategist at ETF Securities

Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).

Time to be Opportunistic in Emerging Markets Bonds

Time to be Opportunistic in Emerging Markets Bonds

No matter one’s point of view, November was a watershed month for global financial markets. The immediate reaction for holders of emerging markets bonds was to sell first and ask questions later. This sell-then-ask process has been the fate of many risk markets over the past decade. For emerging markets bonds, it did not take long for prices to move significantly lower and then usher in the “ask questions” phase. The market reaction was swift, with higher rates and a stronger U.S. dollar. This continued after the Federal Reserve delivered an expected rate increase following their meeting on December 13-14, but with an unexpectedly hawkish forecast for 2017. Time to be Opportunistic in Emerging Markets Bonds

USD Strength Impacts Local Bonds

Hard currency sovereigns were negatively impacted by a 55 basis points (bps) increase in 10-year U.S. Treasury rates in November, ending the month with a return of -4.1%. Investment grade sovereigns were more impacted than the broader universe due to their longer duration. However, higher quality bonds now also provide an approximately 90 bps pickup versus U.S. investment grade corporate bonds, a significant increase in relative value versus October. High yield emerging markets corporate bonds posted a relatively modest negative return of -1.6% due to a shorter duration than other sectors, and remain a bright spot with year-to-date returns of 14.4%. These gains have been driven equally by the significant carry they provide, as well spreads which have tightened year to date (and which remained steady in November).

Extreme volatility in some emerging markets currencies impacted the local currency sovereign space, which declined 7%, with 5% attributable to currency depreciation and the remaining 2% from higher local rates. Within local currency bonds, Turkey and Mexico stood out as laggards in U.S. dollar terms due to the large selloff in their currencies. Although not immune to the broad weakness in emerging markets currencies, Russian and Colombian bonds were the best performers (although still negative for the month), with the former expected to be more insulated from Trump’s foreign policies, and the latter benefitting from a renewed peace deal with FARC (The Revolutionary Armed Forces of Colombia) and posting small positive returns in local terms. In addition, both Russia and Colombia rely heavily on commodity exports and their local bonds received some support from the increase in oil prices that resulted from OPEC’s (Organization of Petroleum Exporting Countries) announced production limits.

What’s Next for Emerging Markets?

The prevailing sentiment post-U.S. election is somewhat pessimistic for emerging markets. The consensus is that fiscal stimulus will more than make up for monetary tightening, spurring a reflationary trend that is likely to occur inside a newly formed bubble of protectionism that will leave many emerging markets without a key engine for growth. Another by-product is that populist/nationalist movements will succeed (as the rejection of the Italian referendum validated in early December) throughout the developed world over the next several years, significantly altering the geopolitical and economic landscape.

Our view is more nuanced. We believe the prospects for emerging markets in 2017 centers around a few critical questions. One: How will higher U.S. rates, should that trend continue, impact flows? Two: Will the U.S. dollar continue its upward trend on the back of higher rates and a wave of protectionism? And three: Can emerging markets growth continue to recover? Consensus is for growth to accelerate slightly in 2017, but sentiment also appears to be that a fiscally led pick-up in developed markets economies will happen largely in a vacuum as trade relationships are under threat. Given years of progress in the opening of global markets, this last assumption is a difficult one to digest, but it also means that the continued rise of the U.S. dollar is not a foregone conclusion.

Be Savvy and Opportunistic Amid the Volatility

Given the uncertainty in the market, economic and political developments (or even an off-the-cuff early morning tweet by President-elect Trump) are likely to keep volatility elevated in the near term.

We believe investors should keep two things in mind. First, the positive note is that from a static perspective, emerging markets fundamentals (growth, debt stock, real rates, and policy flexibility) remain at a favorable starting point relative to developed markets as we enter 2017. While current accounts are more of a mixed story, in many cases they have improved. On the other hand, the less positive note is that the range of potential outcomes in 2017 – for U.S. rates, growth and inflation, EU and Japanese monetary policy – is extraordinarily wide, with opposite or divergent outcomes possible depending on the course of events. While emerging markets assets can do better in 2017 than recent press and analyst coverage may suggest, we believe that being savvy and opportunistic (and contrarian) about adding exposure could help enhance the risk/reward.

November 2016 1-Month Total Returns by Country


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Source: FactSet as of 11/30/2016. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.

so    Head of Fixed Income ETF Portfolio Management
Portfolio Manager for Fixed Income ETFs specializes in international bond markets
Investment Management Team member since 2012
Prior to joining VanEck, Managing Director of Global Emerging Markets with The Seaport Group; launched the firm’s emerging markets fixed income sales and trading business
Previously held portfolio management positions at Greylock Capital and Soundbrook Capital; focused on corporate high-yield and distressed bonds with an emphasis on emerging markets
Earlier career experience includes senior fixed income trading positions at Credit Lyonnais and HSBC
Quoted in Financial Times, Barron’s, and ETF Trends, among others
CFA charterholder; member of New York Society of Security Analysts
MBA (with distinction), Finance, The Wharton School of Business, University of Pennsylvania; AB, History, Princeton University

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Debt securities carry interest rate and credit risk. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer’s financial health. Securities may be subject to call risk, which may result in having to reinvest the proceeds at lower interest rates, resulting in a decline in income. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact a Fund’s return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability.

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