A TALE OF TWO STORIES
2016 will be remebered as the secular peak in US bond markets as the New Kondratieff cycle is unfolding. US 10 year treasury yields bottomed otu at 1.41 % in June before rising back to 2.48 %, leaving US bond investors with a negative year overall.
It is also the year where US monetary policy has been reversed after 8 year of extraordinarily accomodative monetary policies being pursued jointly in Japan, Europe and the US.
The 2008 financial crisis is defintely behind us and the massive rally in bank stocks around the world in December testifies of the fact that the world banking system is now in good shape afater years of re-structuring their balance sheets.
The legacy though is not to be underestimated as Central banks around the world have grown to levels unheard of before and it will take years to offload the stock of government and corporate debt they have accumulated over the years.
Inflation is now back into the system and the next challenge for central banks will be to keep it under control. As always, Central Banks have been erring on the lagging side and will now have to catch up with inflationnary pressures.
The US is ahead in terms of timing having resorted to extraordinary mesure much faster than Japan and Europe, and they will now be ahead of the pack in rising interest rates. This will leave an interest rate gap that will favor the US currency markedly over the Japanese Yen and the Euro.
it is still too early to pile back into fixed rate bonds and Floating rate notes are to be favoured for another 18 months at least.
Bank’s perpetual bonds are also offering great value at current levels.
By contrast emerging market bonds fared very well in 2016.
From Brazil who benefitted for the impeachment of Dilma Rousseff and where bond yields fell by 169 basis points, to India, Russia and even Turkey, emerging bond markets have delivered good performances.
India’s benchmark sovereign bonds had their best performance since the global financial crisis amid record debt purchases by banks, the biggest holders of government securities.
Lenders gorged on debt this year as the central bank boosted cash availability in the financial system and deposits surged following the government’s recall of high-value currency notes.
That, along with a reduction in benchmark interest rates, offset the impact of foreign outflows stemming from the Brexit vote, the Federal Reserve’s monetary tightening and a change at the Reserve Bank of India’s helm.
The benchmark 10-year yield has plunged 127 basis points in 2016, the most in eight years, to 6.49 percent in Mumbai on Friday. It sank to 6.19 percent in November, the lowest close since April 2009. The drop in India’s yield is the steepest in Asia.
Policy makers cut the benchmark repurchase rate twice in 2016, by 25 basis points each, to the lowest in about six years, following a 125-basis point reduction in 2015. Borrowing costs have declined across the curve, with three-month commercial paper rates falling to lowest level since 2010. Rupee-denominated bond sales by Indian companies have surged to a record 4.41 trillion rupees ($64.9 billion) in 2016.
In Europe, UK treasury bonds performed well following the BREXIT vote as local institutions repositionned themselves in local currency, Greek bonds were the best performers as a deal was negociated with the European union and Portugal was the worst performer as fears of default grew in an economy in full resturcturing.
In Asia, chinese bonds were mildly lower while Australia and New Zealand saw th peak of their bond markest as well.
2016 was characterized by a unique period where most major Government bond yields went into negative, something that never happened in the history of the financial markets and the buyers of bonds at these levels will never recover their buying price.
It was a year to offload fixed rate bonds at record high levels and to stay out for the rest of the year.
Current yield levels on most major markest are still unattractive. With most major bond markets yielding less than three percent, inflation willl quickly catch-up.
We expect US inflation to average 2.5 to 3 % in the coming three years and US bond yields to hover between 4 and 5 % ahead.