By Mike Dolan
LONDON, Aug 10 (Reuters) – Global investors hunkered down in
the bunkers of world markets have made their first tentative
moves to re-emerge blinking into the sunlight even though the
coast is still far from clear.
As markets move into the heart of traditionally thin but
often volatile August vacation period, investor anxiety has been
eased by the prospect of a firebreak in the euro crisis, more
monetary stimulus from the world’s big central banks and some
stabilization of economic data and earnings forecasts.
And the seasonal political holidays across Western capitals
over the coming weeks probably reduce what traders call “event
risk”.
In its place, a data release slate topped by likely news of
a contraction of euro zone gross domestic product in the second
quarter and more up-to-date signals on U.S. inflation, retail,
business sentiment and housing will vie for attention. So too
will the at-once inflationary and demand-sapping latest spikes
in oil and food prices, where Brent crude oil priced in euros is
now back close to record highs.
But perhaps the most significant event of the week gone by
and looming over the next seven days was a sharp jump-back in
historically low yields on “safe haven” U.S. Treasury bonds for
the first time in several months after lukewarm auction of
10-year debt Stateside.
There was similar backup in yields on the intra-euro haven
of German government bonds too.
Reasons for the tepid demand ranged from an ebbing of euro
fears after the European Central Bank’s plan to support euro
sovereign debt markets, concern about demand for Treasuries from
overseas central bank reserve managers whose accumulation of
hard currency has eased and inflation anxiety after another jump
in oil and food prices.
But the weeks ahead will be an important test of the extent
to which this presages a long-term shift in the investment
herd’s dominant risk-averse behaviour, not least with holdings
of top-rated government debt already at extreme and historic
highs according to Reuters asset allocation surveys.
“We’d certainly be light on core sovereign bonds in the U.S.
and Europe and don’t see the valuation case for them at all even
given the risk-aversion argument,” said Richard Batty,
investment director at Standard Life Investments in Edinburgh,
adding that corporate credit remained more attractive.
Batty said there was significant “trading risk” of a further
rise in yields, even though he saw a trough-to-peak jump of
about 100 basis points the limit of any move and 2.5 percent
10-year U.S. Treasury yields the maximum acceptable by the U.S.
Federal Reserve – who would consider further quantitative easing
at that point.
“A backup of about a 100bp would be about the limit of what
the authorities would tolerate,” he added. “There are just so
many global and domestic economic headwinds to a sustained
sell-off in bonds.”
Ten-year Treasury yields slipped back on Friday
as surprisingly weak Chinese July export data illustrated the
weakness of the world economy but they set two-month highs
during the week at 1.7310 – a jump of 33 basis points in just
two weeks.
But with yields and coupons on this “safe” debt now well
below inflation, sharp moves like that underscore the growing
risk for asset managers remaining in these low-yielding bunkers.
A sustained jump of 100 basis points in 10-year Treasuries
over a year, for example, would lead to a total returns loss of
about 7 percent loss — quite a hit for conservative asset
managers seeking safety.
The impact on near-zero or even negative yielding German
government bonds of five-year or less maturities is even
sharper.
The relief of capital preservation if held to maturity and
the lower volatility of these assets compared with equity, for
example, is still sufficient draw for long-term managers, but
the growing two-way risks are now balancing the view if global
financial scares are abating.
Many remain cautious about what could go wrong, however.
Nick Gartside, JP Morgan Asset Management’s Chief Investment
Officer for Fixed Income, said it’s hard to judge the durability
of market moves during August and worries that some of the
lowest levels on market volatility gauges since the
Spring are merely ripe for a turn.
“Our concern is that markets, distracted by the Olympics and
unusually clement weather, may be complacent. If we follow the
pattern of 2011, September is likely to be hot. For that reason
portfolios remain defensive.”
EURO GUESSING
While some more upbeat economic news relative to
expectations, as seen in the rise in Citi’s G10 economic
surprises index, has helped sentiment, the biggest spur to risk
appetite has been last week’s ECB pledge to consider euro zone
sovereign bond buying in return for agreed budget programs.
Since just before ECB chief Mario Draghi first flagged the
shift on July 26, two-year Spanish government yields
have been crushed by about 300 basis points and
even 10-year Spanish yields shed more than 80
basis points. The Italian story is broadly similar.
Euro stocks are up a whopping 12 percent over
that time, global stocks MIWD00000PUS> are up almost 7 percent
and Wall St equity record its highest levels since May 1
– just a whisker from 2012 highs.
Beyond the ECB meeting on Sept 6, the rest of next month
contains potential pitfalls such as the German constitutional
court ruling on the European Stability Mechanism, Dutch
elections and ongoing Greek financing negotiations.
Yet many now believe significant ECB intervention and
greater euro integration are inevitable.
“It is only a question of time before the ECB buys sovereign
bonds on a grand scale,” Commerzbank chief economist Joerg
Kraemer told clients on Friday. “The emerging (euro zone)
liability union is undermining the status of German bonds as a
safe haven.”
