Global Weekly: No quiet Christmas

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The year ended with a highly volatile week. The volatility index spiked above 36, its highest level since February 2018.

News around Christmas had been dominated by concerns that US President Donald Trump was turning his frustration with the interest rate policy and the US Federal Reserve (Fed) into a personal crusade against the Fed Chairman Jay Powell.

To make it worse, US Treasury Secretary Steven Mnuchin called major bank leaders, to check whether they had enough liquidity, giving market participants the impression that things are not as smooth as one might think.

Fortunately, several statements from Trump himself and from the Chairman of the White House Council of Economic Advisers confirmed that Powell’s job is safe, convincing markets that we are far away from doomsday. This caused the biggest percentage rebound since the financial crisis.

Furthermore, Amazon announced a series of impressive holiday sales metrics and reported that “tens of millions of people worldwide” had signed up for its Prime service. This was received positively regarding consumer spending overall. The new year started in negative territory, both in Europe and the US. During Wednesday’s trading session, however, markets were able to rebound and conclude the first trading day of the new year flattish.

Big after-market news on Wednesday was the sharp decline in Apple. This followed after a cut to its sales forecast for the holiday season. Management attributed this to weaknesses in Greater China. With the stock down more than 30% over the past three months, Apple is now the biggest victim of the ongoing trade war.

Bonds: a strong start

Bond investors have seen a strong start into the new year. Especially German Bunds performed well. Bund yields decreased to 16 basis points on Wednesday. This was the lowest level since April 2017 and the strongest yield drop since the political turmoil in Italy in May.

Japanese 10-year government bond yields fell below zero and US Treasuries are trading below 2.7%. In the last months, these movements were often explained as a flight to safety, caused by a rising ‘risk-off’ sentiment. They were accompanied by increasing risk premiums for bonds with lower credit quality and weak equity markets.

This time, however, it seems to be slightly different. Equity markets started the year relatively silent and spreads for European corporate or peripheral bonds only rose marginally. European high yield bonds remained flattish since Christmas, and US high yield names were even able to continue their slow recovery. Consequently, the initial strength of Bunds in 2019 seems to be more than just a risk-off movement, although we saw the risk-off sentiment come back again later in the week.

The bond markets seems to be driven by a major expectation shift regarding the central banks’ future policy. Inflation expectations both in the US and the eurozone came down significantly. In line with this development, markets are now pricing in much less tightening than before. For the Fed, investors are currently not even fully anticipating one rate hike for 2019. Also, markets begin to doubt a first rate hike of the ECB before mid-2020. Primary markets could, however, limit the further upside potential for high quality credits. Traditionally, governments and corporations use the start of a year for financing activities, probably leading to an increasing supply.