Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
It had been a risk-on (more of a relief) rally last week driven primarily by one thing: the start of a possible end in sight to the debt ceiling saga. While technically it is still at a stalemate, the narrative has somewhat changed. The “X-date” i.e. the date at which the government runs out of money to meets its obligations (a default) ranges from the first two weeks of June to August. The Democrats and Republicans need to watch the political angle here – spending cuts would affect more Republican states than Democrat which does not bode well for next year’s election. That said, given the way publicly-held Debt to GDP has ballooned (basically doubled in 12 months), the Democrats will find themselves walking a “Treasury Yield” tightrope when it comes to funding requirements. Furthermore, indications so far point to any outcome as being unlikely to provide long-term fixes. If any agreement is reached, it’s likely to be specific - one key area to cut spending is Medicare and Social Security. Both are very, politically sensitive. Furthermore, with several Fed Board members arguing persistently for more rate hikes down the line, the notion that rate cuts are inevitable later this year is staring to evaporate. This was evident in bond yields last week: the 1m Treasury yielded 5.526% (it was up 0.15% on Friday!); the 1y Treasury yielded 5.017%; 2y Treasury 4.259%, 10y Treasury 3.6671%; 30y Treasury 3.937%. The Yield Curve remains inverted – but the front end is painting a steeper picture regarding rate action. With headline inflation at 4.90%, you are earning a real rate of return owning front-end Treasuries – which explains Gold’s drop on the week (now: 1,980) (Source CNBC)
Turkey goes into an election runoff on 28th May: Erdogan’s AKP secured 49.51% of the vote. Although short of the 50% needed for an outright victory, he surprised his opponents and pundits with a far better performance than expected. His main rival, Kilicdaroglu, secured 44.88%. The official turnout was 88.9%. The Ultra-Nationalist candidate to emerge third is Sinan Ogan with 5.17% and will likely be the kingmaker. How Ogan’s vote gets divided will be the deciding factor. He (Ogan) is being courted by both the main rivals. He has set some uncompromising conditions for Ogan such as returning Refugees to their countries and fighting terrorism. On balance, it would look like the result favours Erdogan, but it is not clear whether his supporters will follow his recommendations. For markets, there was a deep selloff. The currency (Lira) reached a new low, the government’s longer-dated 2045 bond fell -3 cents to 71 cents/$, CDS (bond insurance) climbed +0.19% to 6.53%. Net reserves have dropped some -$4.45bn to a 21y low of $2.33bn (w/e 12th May). Gross reserves of banks fell -$9bn to $105.13bn. Amidst the uncertainty associated with the runoff, banks have restricted access to some individual loans and postponed decisions on extending corporate loans. Some have even raised mortgage loan rates to over 3% per month and car loan rates to 4% per month. Personal loans are now near 5% per month ($3,590 pm)!
Finally, two thoughts to end on:
Global Equity Funds: suffered outflows again for w/e 17th May of -$8.72bn. The US (-$7.64bn) and Europe (-$1.81bn) recorded the most. Asian funds saw some inflows ($180mn). Healthcare, financial and energy saw outflows; tech gained.(Source Reuters)
Global Bond Funds: saw inflows of $4.31bn. Short- and medium-term funds drew the most ($3.45bn); HY saw outflows (-$2bn).