Government Bonds

A quick look at the dashboard of 16 fixed income indices I track clearly shows the amount of pain experienced by investors so far this year. Of the 16 indices I follow, which include IG corporates, government bonds and high yield all denominated in sterling, euros and dollars, Bank CoCos, £ and € Sub Insurance, three hard currency corporate EM indices and the G7 govvie index, only two had a positive total return for the year at the end of October.

After some very negative research pieces – some almost sensationally so – on the affect the wider Italian Government Bond (BTP) spreads would have on Italian banks, yesterday we got to see the facts from Intesa Sanpaolo when it  reported its  Q3 earnings.

A question we have been getting more frequently for from clients in recent weeks concerns US Treasuries, and more specifically how the level of UST issuance (and where along the maturity curve it arrives) will impact yields both in the rates market and further afield in the coming months.

Those of you who have seen or heard one of our presentations will be aware of the significant impact that the FX-basis currently has on our relative value bond selection.

A few weeks ago we wrote about the geopolitical risks helping to keep credit spreads wider in Europe and the UK and keeping a lid on US Treasury yields (Is It Time to Buy the Dip?).

Last year, with credit spreads tightening close to historic levels, it seemed appropriate to us to take a more prudent stance and move to a more balanced portfolio.

We have had a lot of discussion, both internally and externally, over the last few days around when might be the time to begin adding more risk to portfolios again.

This significant flattening came about as the Fed signalled its determination to push through policy normalisation, with four hikes now expected for the calendar year 2018, which would take the upper bound of the Fed Funds rate to 2.5% by year-end.

Credit metrics, as measured by the rating agencies, continued to improve throughout the first half of this year, with all corners of the globe having comfortably more upgrades than downgrades.

In recent weeks we have talked often about the tightening of lending standards, the possibility of the end of dot plots, and especially the shape of the US yield curve – today’s blog encompasses all three.

Aside from the fact that he is Italian and once served as governor of the Italian central bank there are other reasons why Mario will be concerned at the price action in Italian Government Bonds (BTPs).

After another week of yield curve flattening, we now have the 2s-10s curve in US Treasuries at just 43 basis points.