Cross-Asset Weekly
10 March 2017
Turning tides
Contacts
Yesterday’s ECB’s press conference turned out to be more eventful than many anticipated. The ECB upgraded its inflation and growth forecasts for 2017 and 2018 while
leaving 2019 unchanged. Yet, it maintained a dovish stance by keeping the “or lower”
in its interest rate forward guidance. But, during the Q&A of the press conference, ECB
president Draghi, in the market’s mind, markedly weakened the same guidance by highlighting that this is an expectation of the Governing Council and not a commitment. We
discuss this and more details of the ECB meeting in our European Macro section. In
the press conference ECB President Draghi was also asked what was causing the drop
in short-term German bond yields. He highlighted investors’ not having access to the
deposit facility as one of the reasons. We detail this factor and name others, which are
likely causing the low yield of 2-year German Bunds, in our European Government Bond
Strategy section.
Dr. Karsten Junius, CFA
Chief Economist
[email protected]
+41 58 317 32 79
With the extremely low yields of 2-year German Bunds the spread to 2-year US treasuries widened substantially. Now, the market is pricing a Fed hike in March almost with
certainty, in addition to another two hikes for 2017, which is increasing the yield of US
treasuries. We analyse the potential of the US households to weather hikes by the Fed.
We believe this to be the case with relative ease, as we detail in our US Macro section.
Adolfo Laurenti
Global Economist
[email protected]
+41 58 317 30 86
Ursina Kubli
Forex Strategist
[email protected]
+41 58 317 32 80
Cédric Spahr, CFA
Equity Strategist
[email protected]
+41 58 317 31 28
Despite higher US treasury yields, emerging market credit spreads continued their
tightening trend. We decompose the asset class’ spread developments by ratings and
regions in our Emerging Markets section.
Dr. Florian Weber, CFA
Fixed Income Strategist
[email protected]
+41 58 317 31 14
This week’s highlights
Emiliano Surballe, CFA
Emerging Market Credit Strategist
[email protected]
+41 58 317 35 64
European Macro
Draghi stresses flexibility of ECB’s forward guidance
2
European Government Bond Strategy
Factors lowering the short-term German bund yield
3
US Macro
How vulnerable is the household sector to higher rates?
4
Emerging Markets
Decomposing EM credit valuations
6
Economic Calendar
Week of 13/03 – 17/03/2017
7
Market Performance
Global Markets in Local Currencies
8
1 | Cross-Asset Weekly
Kunal Singh, CFA
Emerging Market Credit Strategist
[email protected]
+41 58 317 31 21
Thilina Hewage, CFA
Emerging Market Credit Strategist
[email protected]
+65 6230 66 61
Cross-Asset Weekly
10 March 2017
European Macro
Draghi stresses flexibility of ECB’s forward guidance
Dr. Karsten Junius, CFA
Chief Economist
[email protected]
+41 58 317 32 79
The ECB did not change its policy statement but made small changes in its communication indicating that it is on a slow path towards a less accommodative
monetary policy. Most importantly, Draghi explained that the Governing Council is
not committed to keeping interest rates at the current or lower level for a prolonged period – it just “expects” them to remain there.
Governing Council seems to prepare less
dovish messages
It seems not to be that easy to find a way out of the ultra-expansionary monetary policy. At least, that was our impression after the ECB-press conference yesterday. Draghi
pointed out that the Governing Council (GC) dropped one standard sentence from the
introductory statement (“If warranted to achieve its objective, the Governing Council will
act by using all the instruments available within its mandate”). But he did not explain
what instruments the GC would not use anymore. Was this a mere reference that
TLTROs will not be offered in the future, as Draghi pointed out later? The exchange rate
channel, OMT, …?
Forward guidance to keep interest rates
low is not a commitment
Similarly confusing was his explanation regarding the future interest rate path when
confronted by the observation that money markets are already pricing in rate hikes for
this year. He could have clearly dismissed the idea. But, instead he chose to explain
that the forward guidance of the ECB only expresses an expectation of the GC. It would
not be a commitment. Formally, that is correct. Central banks cannot and should not
pre-commit to a certain policy path – which is why forward guidance has always been a
potentially time-inconsistent policy tool. However, pointing out this so clearly as Draghi
did weakens this instrument and ECB communication unnecessarily. Additionally, he
explained that the GC discussed changing the forward guidance by dropping the reference to lower rates. It seems clear that this can be expected at one of the next two
meetings.
ECB sees stronger growth but is less certain how fast this translates into higher inflation
As expected, the ECB increased its staff projections for GDP and inflation for this year
and next. It did not change 2019 projections for GDP and headline inflation but increased the 2019 forecast for core inflation to 1.8%. (It was probably the flatter curve
of oil price futures that did not allow an according increase of headline inflation.) Additionally, Draghi highlighted that the risks are less pronounced but are still tilted to the
downside. In any case, staff projections were based on full implementation of all policy
measures – which means that higher inflation forecasts are no reason to reduce QEpurchases.
We except that the ECB continues on its
gradual but steady path of reducing monetary policy accommodation
The next ECB-meeting takes place in between the 1st and 2nd round of the French presidential elections. Changes to its policy stance are more likely at the June meeting but
Draghi might prepare them in May already. As a first step, the ECB could change its
forward guidance by (1) excluding the reference to lower interest rates and (2) shortening the time span that they indicate interest rates to remain at the current level. We do
not expect any changes to the monthly purchase volume this year. A decision to extend
asset purchases beyond the end of the year and to reduce or wind them down should
be due at the September meeting. It seems that the “hawks” in the GC may want to
seize that opportunity by tying a decision to extend bond purchases to a clearer perspective that negative interest rates are not to stay forever. This confirms our assessment that the Bund curve should steepen further.
2 | Cross-Asset Weekly
Cross-Asset Weekly
10 March 2017
European Government Bond Strategy
Factors lowering the short-term German bund yield
The yield of short-term German bonds has fallen back to their record lows after the
ECB revealed it has shortened the average maturity of its purchases in February to
4.3 years. We see five factors, which, in our view, are supporting short-term German bonds. We maintain the view that the German 2s10s should steepen during
2017.
Dr. Florian Weber, CFA
Fixed Income Strategist
[email protected]
+41 58 317 31 14
We believe there are five factors lowering
short-term German bond yield
Short-term German bond rallied again to their record low yield after the ECB revealed it
has shortened the average maturity of its purchases in February to 4.3 years – the lowest on record since the ECB’s QE programme began (see Exhibit 1). During yesterday’s
ECB press conference, ECB President Draghi was asked what is causing the drop in
short-term German bond yields. He highlighted investors, which don’t have access to
the deposit facility as one of the reasons. These investors are foreign banks and in
particular foreign central banks like the Swiss National Bank (SNB). This means currency interventions are important to monitor. Besides, the SNB, the Danish National Bank
and the Czech National Bank “manage” their currency against the euro. Neither has
access to the ECB’s deposit facility, and therefore, their currency interventions are likely recycled into the German bond market. We discussed this in case of the SNB in last
week’s cross asset weekly (see “A stronger cyclical upswing brightens the outlook” –
Cross Asset Weekly, 3-Mar-17). Since the beginning of the year, the currency interventions of the three central banks have reached €54bn. To put this number into perspective, the amount is approximately 1.5x the ECB’s QE purchases over the same time period. However, it is only one of the five factors, which are supporting 2-year German
bonds. We believe 2-year German bond yields are at the current level due to the following drivers:
1.
2.
3.
4.
5.
Regulatory changes require banks to hold high quality liquid assets (HQLA)
ECB’s QE programme is shifting towards shorter maturity German bonds
Foreign official sector demand due to currency interventions
Foreign private sector demand for German bonds is also increasing
Germany is reducing its issuance in the 2-year sector
Exhibit 1: Weighted average maturity of German bond purchases
fell to 4.3 years in February
€35bn
Danish
11
€30bn
Czech
10
€25bn
Total
12
in years
Exhibit 2: Currency interventions reached €54bn since the beginning of the year
Germany
9
Swiss
€20bn
8
€15bn
7
€10bn
6
€5bn
5
4
€0bn
Mar-15
Jul-15
Dec-15
Apr-16
Sep-16
Jan-17
Source: European Central Bank , J. Safra Sarasin, 08.03.20177
3 | Cross-Asset Weekly
Jan-16
Apr-16
Jul-16
Oct-16
Jan-17
Source: Bloomberg, J. Safra Sarasin, 08.03.2017
Cross-Asset Weekly
10 March 2017
US Macro
How vulnerable is the household sector to higher rates?
Despite the imminent Fed hike, we are not concerned that household finances
could be crippled by rising rates. Home mortgages and student debt, which are the
most important liability for households, are fixed-rate instruments and relatively
immune to further Fed tightening. Credit card debt, more vulnerable to changes in
short-term rates, is not at alarming levels.
Adolfo Laurenti
Global Economist
[email protected]
+41 58 317 30 86
We do not think that the resilience of the
US consumer is at risk because of the imminent Fed rate hike
The burden of financial obligations is low
because of the low interest rates in recent
years. There is little evidence of significant
releveraging
Mortgage debt is in check and relatively
immune from rising short-term rates
As the Federal Reserve nears the first rate hike of the year, it is reasonable to worry
about the potential impact of monetary tightening on household finances. Consumer
spending accounts for 70% of US GDP, and excesses in mortgage financing were at the
epicentre of the 2008-2009 financial crisis. Will the Fed’s hike slow down the everresilient US consumer? We don’t think this will be the case at this stage.
Households: strong balance sheet, with some vulnerable spots
Thanks to very low interest rates in recent years, the burden of financial obligations for
households is at the lowest levels since 1990 (see Exhibit 1). The largest liability on
families’ balance sheets (see Exhibit 2), home mortgages, should be rather resilient to
a Fed hike, for at least two reasons. First, the vast majority of mortgages (about 85%,
according to the Fed’s estimate) are fixed-rate. Payments do not reset as interest rates
rise. Second, lending terms are fairly lengthy, as more than 60% of all mortgages are
originated as 30-year fixed-rate contracts. The bottom line is that most families were
able to lock-in the low rates of the past few years, and they will carry these conditions
until the loan will be repaid.
A lessened financial burden of mortgage debt is only one of the factors at play. Total
mortgage debt also declined since its 2007 peak, both relative to GDP and in absolute
terms (see Exhibit 3). The deleveraging of household balance sheets is a positive outcome, considering that consumer spending did not suffer a significant adjustment during the process. The trend was also facilitated by the decline in homeownership rates
from 69% in 2004 to 63% in 2016. The percent of families with home-secured debt also fell from 49% in 2007 to 43% in 2013, the last year for which we have data from
the Survey of Consumer Finances published by the Fed.
Exhibit 1: Lessened burden: household financial obligations as a
percent of disposable income
19
Exhibit 2: Household liabilities dominated by home mortgages
14.000
$ trillion
12.000
18
10.000
17
8.000
Other
Student Loan
Credit Card
16
6.000
4.000
15
Auto Loan
Mortgage
2.000
14
1990
1995
2000
2005
2010
2015
Source: Datastream, J. Safra Sarasin, 09.03.2017
4 | Cross-Asset Weekly
0.000
Source: Datastream, J. Safra Sarasin, 09.03.2017
Cross-Asset Weekly
10 March 2017
Credit cards rates will rise in sync with the
fed funds rate set by the Fed. In this case,
too, deleveraging made US households less
vulnerable
Credit card debt shows similar dynamics. In this case, the risk stemming from Fed policies is direct, because credit card rates are linked to the prime rate, which moves in
sync with the fed funds rate. A sudden rise in rates would have an immediate impact
on the financial burden of families who carry a monthly balance. According to some Fed
estimates, about 38% of all households are indeed in this position. Even in the case of
credit card debt, though, it appears that some degree of deleveraging has taken place.
As shown in Exhibit 4, revolving credit outstanding is slowly recovering its 2007 high,
but relative to GDP it remains in line with its early 1990s levels.
Student loan debt is a problem for younger
generations. Its fixed-rate terms make it
less vulnerable to Fed hikes
Other forms of debt (auto loans, student loans, etc.) vary in lending terms and pricing
structure. In particular, student loans are a major concern for younger generations. Millennials bear the largest share of this type of debt, which has exploded in recent years.
Fortunately, student loans tend to carry a fixed rate, which should provide a buffer
against the Fed tightening.
US households, having locked-in low rates
for their mortgages and student loans, are
in a good position to withstand higher
short-term rates
Conclusions
On net, American households appear to be in fairly healthy financial conditions. The
deleveraging process that followed the Great Recession is coming to an end, and mortgage debt remains at moderate levels. Both revolving (credit cards) and nonrevolving
(student loans, auto loans) debt is rising, but only credit cards rates are at direct risk
to jump as the Fed raises rates. Higher long-term rates will dent housing affordability,
but those consumers with mortgage debt are likely to have locked-in low rates for the
long haul. All things considered, in coming months households are in a reasonably
good position to withstand the Fed’s decisions.
Exhibit 3: Successful deleveraging of household mortgage debt
after the 2009 shock
100
12000
Exhibit 4: Credit card (revolving) debt remains in check
1200
8
Home mortgages as percent of GDP
90
10000
Home mortgages ($ bn, RHS)
7
1000
6
80
8000
800
5
70
6000
4
600
60
4000
50
Revolving consumer credit
outstanding, as % of GDP
400
Revolving consumer credit
outstanding ($ bn, RHS)
200
2
2000
40
30
1990
3
0
1994
1998
2003
2007
2011
2016
Source: Datastream, J. Safra Sarasin, 09.03.2017
5 | Cross-Asset Weekly
1
0
1990
0
1994
1998
2003
2007
2011
2016
Source: Datastream, J. Safra Sarasin, 09.03.2017
Cross-Asset Weekly
10 March 2017
Emerging Markets
Decomposing EM credit valuations
Kunal Singh, CFA
Emerging Market Credit Strategist
[email protected]
+41 58 317 31 21
• The recent spread performance in EM corporates has been driven by both the IG
& HY segments; Latin America has the cheapest valuations within EM regions
• Within EM sovereigns, the high yield segment has outperformed IG during the
recent rally. Latin America screens as most attractive on valuations.
The emerging markets hard-currency credit asset classes (sovereign and corporates)
have seen spreads grind tighter since mid-November 2016. This spread tightening has
been an extension of a rally that began in February 2016, as commodity prices rebounded, but was temporarily disrupted in the aftermath of the US election result. In
the sections below we decompose the asset class spread development into its ratings
and regional constituents to explore divergence in valuations of these segments post
the recent rally.
Corporates currently trading close to historic tights
Corporates: Since November 14th 2016, the CEMBI Broad has seen a spread tightening
of 59bps, and currently trades around 12bps wide of its 5-year tights. This spread performance was driven by tightening in both the IG and HY segments of the index. Consequently, spreads in these rating segments are currently trading around the tightest
levels relative to history. Within EM regions, Latin America screens the most attractive
on a relative basis with spreads around 76bps wider to historical tights, while Asia
screens the most unappealing on valuations. Further, the current pick-up of the corporate spread (CEMBI Broad) over sovereigns (EMBI Global) has compressed to around 32bps as compared to its 5-year historical average pick-up of around +7bps.
Sovereigns have outperformed corporates
since mid-November
Sovereigns: During the period under review, the EMBI Global witnessed a spread tightening of around 75bps, outperforming the CEMBI Broad. However, in contrast to the
corporate index, the EMBI Global currently trades around 87bps wider to its historical
tights leading to more appealing valuations. Within the rating buckets, the HY segment
outperformed with a spread tightening of around 99bps while spreads in the IG segment compressed by around 57bps. Similar to the corporates, Latin America has the
most attractive valuations relative to other EM regions with spreads trading close to
the historical average. Again, Asia looks to have the most stretched valuations with
spreads just 22bps wide to historical tights.
Spreads of the CEMBI Broad and its sub-segments vs. their 5-year range
Spread (bps)
1,400
5-year range
Last
1,000
600
200
CEMBI Broad IG
HY
LATAM
Brazil
Mexico CEEMEA Russia
Turkey
ASIA
India
China
Source: Bloomberg, J. Safra Sarasin, 10.03.2017
6 | Cross-Asset Weekly
Cross-Asset Weekly
10 March 2017
Economic Calendar
Week of 13/03 – 17/03/2017
Country Time
Item
Date
Unit
Monday, 13.03.2017
CH
10:00 Total Sight Deposits
10:00 Domestic Sight Deposits
Mar 10 CHF
Mar 10 CHF
Tuesday, 14.03.2017
CN
03:00 Retail Sales
03:00 Industrial Production
EMU
11:00 Industrial Production
11:00 ZEW Expectations
DE
11:00 ZEW Expectations
US
11:00 NFIB Small Business Optimism
13:30 PPI Final Demand
13:30 PPI Final Demand
13:30 PPI ex Food & Energy
13:30 PPI ex Food & Energy
Feb
Feb
Jan
Mar
Mar
Feb
Feb
Feb
Feb
Feb
Wednesday, 15.03.2017
CH
09:15 Producer & Import Prices
EMU
11:00 Employment
11:00 Employment
US
13:30 CPI ex Food & Energy
13:30 Retail Sales Advance
13:30 - Less Auto
15:00 NAHB Housing Market Index
15:00 Business Inventories
19:00 FOMC Rate Decision (Upper Bound)
19:00 FOMC Rate Decision (Lower Bound)
yoy
yoy
mom
index
index
index
mom
yoy
mom
yoy
Feb
yoy
4Q
qoq
4Q
yoy
Feb
yoy
Feb
mom
Feb
mom
Mar
index
Jan
index
Mar 15 %
Mar 15 %
Thursday, 16.03.2017
EMU
11:00 CPI
UK
13:00 BoE Sets Interest Rate
US
13:30 Housing Starts
13:30 Philadelphia Fed Business Outlook
14:45 Consumer Comfort
14:45 Economic Expectations
Feb
mom
Mar 16 %
Feb
1 000
Mar
index
Mar 12 index
Mar
index
Friday, 17.03.2017
EMU
11:00 Construction Output
US
14:15 Capacity Utilization
14:15 Manufacturing Production
Jan
Feb
Feb
yoy
index
mom
Consensus
Forecast Prev.
- 553.4
- 471.5
+10.7%+10.4%
+6.2% +6.0%
- -1.6%
- 17.1
- 10.4
- 105.9
0.0% +0.6%
+1.8% +1.6%
+0.2% +0.4%
- +1.2%
+2.2%
-0.1%
+0.1%
65.0
+0.3%
1.0%
0.8%
+0.8%
+0.2%
+1.2%
+2.3%
+0.4%
+0.8%
65.0
+0.4%
0.8%
0.5%
- 0.25%
1255 1246
25.0 43.3
- 50.0
- +3.2%
75.5% 75.3%
- +0.2%
Source: Bloomberg, J. Safra Sarasin
7 | Cross-Asset Weekly
Cross-Asset Weekly
10 March 2017
Contacts
Dr. Karsten Junius, CFA
Chief Economist
[email protected]
+41 58 317 32 79
Adolfo Laurenti
Global Economist
[email protected]
+41 58 317 30 86
Ursina Kubli
Forex Strategist
[email protected]
+41 58 317 32 80
Cédric Spahr, CFA
Equity Strategist
[email protected]
+41 58 317 31 28
Dr. Florian Weber, CFA
Fixed Income Strategist
[email protected]
+41 58 317 31 14
Emiliano Surballe, CFA
Emerging Market Credit Strategist
[email protected]
+41 58 317 35 64
Kunal Singh, CFA
Emerging Market Credit Strategist
[email protected]
+41 58 317 31 21
Thilina Hewage, CFA
Emerging Market Credit Strategist
[email protected]
+65 6230 66 61
Market Performance
Global Markets in Local Currencies
Government Bonds
Swiss Eidgenosse 10 year (%)
German Bund 10 year (%)
UK Gilt 10 year (%)
US Treasury 10 year (%)
French OAT - Bund, spread (bp)
Italian BTP - Bund, spread (bp)
Current value
Δ 1W
Δ YTD
TR YTD in %
-0.14
0.34
1.20
2.50
59
177
7
16
12
19
-16
-24
4
13
-4
6
11
16
0.4
-0.2
1.0
0.0
Spread over
govt bonds
Credit Markets (bp)
US Investment grade corp. bonds
EU Investment grade corp. bonds
US High yield bonds
EU High yield bonds
Stock Markets
60
69
307
275
Change in credit spread
Credit index
Δ 1W
Δ YTD
TR YTD in %
2
6
11
21
7
3
47
13
0.7
0.0
3.3
1.7
Level
P/E ratio
1W TR in %
TR YTD in %
8 652
12 033
19 571
9 737
3 392
7 368
2 382
5 363
19 469
936
17.5
13.9
13.4
13.9
14.5
14.9
18.4
20.2
18.4
12.6
1.8
0.9
3.3
2.3
1.5
1.6
0.8
0.6
1.1
-1.6
6.1
5.0
1.3
4.5
3.2
4.2
6.8
10.5
2.4
8.7
Forex - Crossrates
Level
3M implied
volatility
1W in %
YTD in %
USD-CHF
EUR-CHF
GBP-CHF
EUR-USD
GBP-USD
USD-JPY
EUR-GBP
EUR-SEK
EUR-NOK
1.01
1.07
1.24
1.05
1.22
114.5
0.86
9.53
8.93
7.9
7.0
8.6
9.8
9.5
11.3
10.2
6.8
7.3
0.4
0.2
-1.5
-0.2
-1.9
2.1
1.7
-0.2
0.9
-0.7
-0.5
-1.7
0.2
-0.9
-2.1
1.0
-0.5
-1.7
SMI - Switzerland
DAX - Germany
MIB - Italy
IBEX - Spain
DJ Euro Stoxx 50 - Eurozone
FTSE 100 - UK
S&P 500 - USA
Nasdaq 100 - USA
Nikkei 225 - Japan
MSCI Emerging Markets
Commodities
Level
3M realised
volatility
1W in %
YTD in %
CRB Commodity Index
Brent crude oil - USD / barrel
Gold bullion - USD / Troy ounce
434
55
1 228
5.2
19.0
10.6
5.0
-1.8
-2.3
2.6
-1.6
7.0
Source: J. Safra Sarasin, Bloomberg
8 | Cross-Asset Weekly
Cross-Asset Weekly
10 March 2017
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Cross-Asset Weekly
10 March 2017
Explanatory notes regarding the analysis:
Insofar as factual information and the opinions of third parties (interpretations and estimates) are presented, the relevant sources are indicated. Our own value judgments (projections and forecasts) which reflect the outcome of work undertaken by the Bank's Research department, are not expressly marked or indicated. The substantive principles and benchmarks underlying our own value judgments are set down
in our research methodology principles. In producing the research the following valuation principles and methods were applied:
Economic & Strategy Research
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rates, government budget balances and foreign trade balances. Based on the macroeconomic scenario, the strategists for the three asset
classes work up their forecasts for (a) the stock markets, (b) short- and long-term interest rates, and (c) the major currencies. In addition to
the macroeconomic variables, Economic & Strategy Research consults a variety of different valuation models and short-term market timing
indicators. The forecast horizon is two years into the future for macroeconomic indicators and up to one year into the future for financial
markets.
This publication was prepared on the date indicated. The bank does not undertake any obligation to update this publication.
Discrepancies may emerge in respect of our own financial research from the twelve months preceding publication, relating to the same financial instruments or issuers.
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