Weekly Global Aggregate Fixed Income Strategy

Weekly Global Aggregate Fixed Income Strategy

- OW USD against EUR and JPY bonds.
- Slightly Short Duration
- Almost Neutral in Yied Curve, skewed toward a slightly Steepener
- Neutral in Sector, but OW IG Financial Corp. against UW MBS in US on a relative trading

It's not a simple risk-off, albeit many participants expect bear market in equities is not ended. This view relies on a fear about sell-off safe haven bonds such as UST and German Bund by EM, China particularly as their foreign exchange reserves have been deteriorated somewhat rapidly. In line with this, last week, SocGen argued PBoC sold US treasury bonds by more than 100 billion dollar during last 2 weeks as their FX regime changed.

Under this circumstance, if worries about Chinese economy and a stability from capital outflows deepen further, or transfers to a financial crisis, it would not be a good news for global bonds market. Not only in China, but also in another emerging countries including oil producers mainly are showing their foreign reserves to decline. This is absolutely not the same picture that the Fed funds rate lift-off from 2004 did not lead the upward pressure in long-end rate, in contrast to weigh on short-end and mid term interest rates. We call it as Greenspan's conundrum. But, for now, apparently this is not same with that. A little bluffs Fed should conduct another QE rather than rate hike. But, QE4 would be possible, if US treasury 10 year rate soar by more than 100bp from now.

Or in the case of that Chinese risk does not transfer to a financial crisis and is proved only short-term risk, Fed should be encouraged to raise their funds rate soon. US economy has improved as not only consumption parts but also investments part contributed to economic growth in 2Q this year. Although inflationary pressure remains subdued for now, as a result, private real term disposable income and consumption expenditures are increasing faster than previous year's rate. In fact, soared savings rate in July could signal conditions about spending are not sufficient yet. But, given solid labor markets, both of income and consumption could be spurred soon. At once, some last sentiment index in both of consumer's and business' signaled somewhat woes about coming employment conditions, but recent data indicates rebound of the conditions. That said, in this case, US treasury bond could be pushed higher by possible Fed funds rate hike in all tenors of maturities, from short-end to long-end tenor pressured by continuing sell-off by EMs.

(I considered shortly flattening pressure on a chart analysis posted earlier. But, for now, I became somewhat cautious about the yield curve)

Considering these two extreme scenario, the bond price hardly could gain in near term. So, total duration position would be shorter, but a big short will not likely be a good choice as massive volatility is to be considered as well. The yield curve position, in line with this either, would be on the small steepner as Fed doesn't seem to raise policy rate in September and the inflationary pressure would be amplified especially in late this year. But, yield curve seems more difficult to positioning now. So, I recommend to decrease curve positions to neutral, if the spread such as 5s30s and 10s30s widen further.

There is a risk scenario that China is not so bad, but the woes that longer-run economic conditions or/and equity market prices would face a big headwind by strong USD, burden of inventory/sales ratio, and other structural problems, which could not tolerate lift-off rates. But, this case would be based on a given scenario of Fed fund rate hike. So, we could have some time to increase our duration position. But, the yield curve could be flatten earlier, so I am very cautious about yield curve.

And, how should we deal with the distribution of currencies?  Are we ahead of possible QE in ECB and BOJ? If then, we have to overweight EUR and JPY position against USD bonds.
But, I don't think so. In Japan, although someone argues the additional monetary easing is needed, considering some critics that QE led improvement only in companies through depreciation of JPY, which did not spur household's wealth, it seems somewhat difficult BOJ to conduct another QQE from now. Recent comments by governors underpin this view. And in ECB, recent appreciation of ECB against USD has caused the possibility of expanding QE program. But, on a prospect that current QE started as Greece's woes intensified, another monetary easing would not be easy under possible inflationary pressure in the end of this year.

So, I prefer long USD bonds against EUR and JPY bonds as considering opposite scenarios of bull and bear global bond markets. In Euro area, peripheral bonds seem somewhat attractive as aversion of risk asset would be diminished further under shrinking fears about China. UKT seems more attractive than core countries in Euro area.

In Sector, as I posted last week, I prefer OW US IG Corp. bonds especially in financial sector as a defence sector against MBS because the spread between these two widened rapidly during last weeks. On a total positioning, I pursue neutral position on non-treasury bonds with possible volatility in global financial markets.