Date: October 18, 2018
Treasury Yields Seen Capped at 3.5% as Stocks Drop, Newton Says
Treasury yields are unlikely to rise much further as higher Federal Reserve interest rates weigh on the U.S. economy and push down stock prices, according to Newton Investment Management. Benchmark 10-year yields may still climb for a while but will probably fail to breach 3.50 percent, said Paul Brain, head of fixed income at the London-based money manager, which oversees the equivalent of $67 billion. U.S. sovereigns will be supported as a topping out of major stock markets by the middle of next year sends investors fleeing back to haven assets, he said. “I would say it’s possible you get higher yields, especially if inflation expectations start to rise, but it’s unlikely because the vulnerability of the equity market will suppress them,” Brain said in an interview last Thursday in Sydney. “By the middle of next year, higher borrowing costs will lead to lower investments and equity prices need to come down.” Global financial markets are approaching a crossroad with higher Fed interest rates and a U.S.-China trade war sapping demand for higher-risk assets. American shares tumbled last week, with some investors attributing the decline to those concerns, after a series of record highs this year. Benchmark 10-year Treasury yields were at 3.15 percent as of 10 a.m. in London, having climbed to a seven-year high of 3.26 percent last week. Treasury yields would have risen even more over the past few years due to the increasingly hawkish Fed, but the move was restrained by concern a removal of central bank liquidity would push down risk assets, Brain said. Newton would consider boosting its Treasury holdings if 10-year yields reach 3.40 percent or 3.50 percent, as long as equities start to decline, he said. The asset manager would initially purchase Treasury Inflation Protected Securities given its prediction that U.S. inflation will accelerate. “The reason why you buy Treasuries is not for the yield itself,” Brain said. “It’s because of the stuff elsewhere that you are worried about, and it’s the equity sell-off that would prompt you to buy Treasuries.”
Italian Bond Exchange Takes Advantage of Calm Before Storm
Italian markets may be in for a rocky couple of weeks, but the government still needs to finance the second-largest stock of debt in the euro area. The country exchanged 3.8 billion euros ($4.38 billion) of inflation-linked bonds, known as BTP Italia and primarily held by retail investors, for longer-dated nominal securities. That’s more than the original 3 billion euros sought. By doing so, the Treasury is taking advantage of a period of calm before two credit rating decisions and the European Commission response to Rome’s budget plans that are in breach of European Union rules at face value. “They need to raise cash so finding a quiet time to do that is important,” said Ciaran O’Hagan, head of European rates strategy at Societe Generale SA. The Italian Treasury “needs to refinance maturing debt by issuing new bonds and that process is almost continuous given that Italy is Europe’s largest issuer.” Italy’s curve continued to steepen Thursday, with difference between two- and 10-year yields hitting 222 basis points, the highest level since March. Italy is buying back the BTP Italia maturing in April 2020 and selling bonds maturing in 2025, 2028, 2029 and 2046 through a syndication of banks, in line with its debt-management guidelines and “considering the large redemption volume of the BTP Italia,” according to the statement. Final terms were reached for tender and re-openings with final yields set for the five bonds on offer. Italy’s 10-year yields extended an advance and were up 6 basis points to 3.61 basis points at 1:05 p.m. in London. The exchange may benefit domestic banks too, which also own the securities, while there was speculation that dealers of Italian securities may be facing shortages of the nominal bonds being sold. Italy’s yield curve has also come under pressure as recent turmoil over its budget has pushed up those on short-dated securities, while longer-dated yields have stayed relatively anchored. The cash bond market has struggled with liquidity.
China Stock Market Rocked by Forced Sellers; Yuan Hits Fresh Low
Chinese shares extended the world’s deepest slump and the yuan touched its weakest level in almost two years, testing the government’s ability to maintain market calm as risks mount for Asia’s largest economy. Fears of widespread margin calls fueled a 3 percent tumble in the Shanghai Composite Index, which sank to a nearly four-year low as more than 13 stocks fell for each that rose. Efforts by local governments to shore up confidence in smaller companies failed to boost sentiment. The yuan slid beyond its closely watched August low after the U.S. Treasury Department stopped short of declaring China a currency manipulator, a move that some interpreted as giving Beijing breathing room to allow a weaker exchange rate. Chinese policy makers face a tough balancing act as they try to maintain financial stability amid slowing economic growth, a trade war with America and rising U.S. interest rates. Beijing has so far refrained from major market rescue efforts of the sort that followed the nation’s 2015 equity crash, but some investors are calling for bolder action. With $603 billion of shares pledged as collateral for loans, or 11 percent of China’s market capitalization, one concern is that forced sellers will tip the market into a downward spiral. “It’s high time the state stepped in,” said Dong Baozhen, a fund manager at Beijing Tonglingshengtai Asset Management. “The national funds cannot just sit on the sidelines and watch this atmosphere of extreme pessimism.” While the so-called national team of state-backed funds has intervened to support the market in the past, efforts recently have been led by local governments. Officials in the southern cities of Shenzhen and Shunde as well as Beijing’s Haidian district have moved to help listed firms in their areas, according to local authorities and media reports. At least 36 companies have seen pledged shares liquidated by brokerages since the start of June, according to company filings. The Shanghai Composite closed at 2,486, its lowest finish since November 2014. The gauge has slumped about 30 percent from a January high.