US

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.

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.

This week Jerome Powell and his fellow FOMC members sit down to determine the Fed Funds rate, and despite the expectation of no move, this meeting is going to be very closely monitored with market participants analysing every word of the subsequent comment.

With markets now pricing in two cuts in the Fed Funds rate this year, and a 97% chance of at least one cut, once again the FOMC members are at odds with the financial markets.

One of the main drivers of global markets at the moment is the exact status of the economic cycle in the United States, and on a related note, what the Federal Reserve’s next moves are likely to be. One question we are being asked more and more often by investors is whether we think a recession is coming in the US, and if so, when?

Last Friday’s strong US GDP reading for the first quarter has sparked several days of debate between TwentyFour portfolio managers. The 3.2% reading was 100bp ahead of consensus, so a strong beat at the headline level, but the components accounting for it, such as inventory building, suggested the figure was an aberration and likely to reverse in Q2.

TwentyFour Asset Management, the London-based fixed income boutique of Vontobel Asset Management, has appointed Paul Kim as an analyst in its New York office.

Emerging Market (EM) bonds have had a good year so far. While they are not at the very top of the performance table, the hard currency CEMBI (Corporate Emerging Markets Bond Index) is up 5.69% in $ since the start of the year, and the EMBI (Sovereigns) is up 6.32%; not bad at all.

Since the start of the year credit markets have been very well supported, reversing much of the sharp period of spread widening we experienced in the final quarter of 2018.

One of the elements we look at on our dashboard that guides us on the state of the economic cycle is credit rating migration. We look at spread movements too, but rating change gives us another line into the risk that rated entities are taking or are confronted with. While we recognise that rating change is a backward looking indicator, viewed in conjunction with other measures, it is possible to draw some important conclusions.

Investors decided fairly early this year that, with the help of a dovish Federal Reserve, the big negative move of Q4 2018 was not signalling the beginning of the end, and was instead a dip to be taken advantage of. The rally since has barely paused for breath, with a sustained and broad-based recovery taking hold.

Investors have rightly been concerned about the coordinated global economic slowdown, but in Europe it has been worse than that with the major economies flirting with recession. Consequently investors have been cautious on European assets, but has this caution now reached its peak?