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Treasuries on the Move

The most noteworthy development in fixed income markets in recent weeks has been the combination of higher treasury yields and tighter credit spreads.

Part of this dynamic is probably explained by somewhat more positive expectations about the global cycle as tentative signs of bottoming have emerged and hopes have increased that the ECB will be more effective in fighting the excessive risk premiums in European peripheral bond markets. At the same time, it should also be noted that this market dynamic is also part of the broadening “search for yield” theme as negative yields in T-bill and (short) money market space are forcing many fixed income investors into higher yielding corporate credit and emerging market debt space.

Both German and US treasury yields have moved up 30 to 40 bps over the couple of weeks and hint at a serious shift in underlying trends. In June German Bunds have already once made a similar upturn, but that move was then not joined by other major treasury markets (like those in the US, the UK and Japan). The fact that all developed treasury yield are now moving up at the same time suggests that their might now be a stringer and broader undercurrent at play that could persist for a bit longer. Also, given the move in equity markets over the last two months (global MSCI world up more than 10%), the sell-off in treasuries is not extreme and might have further to go if equities do not fall back.

Treasuries on the Move

In this environment we have decided to bring treasuries to a small underweight position in our allocation stance. Next to the less supportive flow dynamics (moving more to higher yielding assets) and the shift in underlying momentum in global treasury markets, the turn in data surprises (3m change in global surprises is now positive for the first time since March) also adds to our conviction that treasury yields could drift up a bit further.

In Europe, the success of the ECB to convince markets that they will intervene (if needed) in peripheral bond markets is also an important element and has significantly reduced yields on Spanish and Italian government bonds. This could also push up German yields once some of the "safe haven" flows reverse course or at least marginal inflows into core European treasury markets soften.

To some extent one could argue that many of the arguments above hold a bit more strongly for US treasuries than for German bunds. Most noteworthy in this respect is the fact that US treasuries have recently moved to a new 3-month high, while German bunds are still within their 3-month trading range. Also, US treasuries might be somewhat less sensitive than Bunds for possible policy induced volatility in September when we have another important ECB meeting, a Troika report on Greece, the German constitutional Court decision on the ESM and the Dutch elections. At the same time, one has to acknowledge that US treasuries and German Bunds continue to be highly correlated and only very rarely move in different directions.

While we continue to overweight spread products in general, we altered some of our intra-spread preference as the strengthening „search for yield‟-dynamic and somewhat reduced Euro crisis fears have increased support for European corporate credit markets. Emerging market debt has outperformed most other spread products on a risk-adjusted basis for most of the last two years, but that seems to be changing now. Inflation is staging a rebound in the emerging world, some large countries have country specific macro issues (for example China, India, Brazil and Indonesia) and relative return momentum in both EM debt and FX has weakened in recent weeks. Taking this together we decided to upgrade European IG credit (to a medium overweight) and Aaa ABS (from max to firm underweight) and downgrade EM exposure, both HC (to a small overweight) and FX (to a medium underweight).

Treasuries on the Move

By Valentijn van Nieuwenhuijzen
Head of Strategy


Vendredi 14 Septembre 2012

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