Ready to unwind? Telling the time in bond markets

Our current macro view is that bond markets are in the middle of a transition year. This is owing to the gradual US monetary tightening process currently underway, which has a negative impact on different sectors of the bond market at different stages in the economic cycle.

First to feel the negative impact of the tightening were developed-world government bonds, followed by emerging-market sovereign bonds. Finally, the effects ripple out into the real economy and thus to high-yield corporate bonds. To help map out how this process plays out, we have put together the clock below, to show which parts of the bond market are affected, and at what ‘time’ in the market cycle.

Prior to 2016, we were at midday on the clock – the growth stage – when economic growth was strong and monetary policy was loose. Then the US Treasury market started to react to the US Federal Reserve’s (Fed) decision to raise rates and talk of reducing its balance sheet, which sparked a sell-off in US Treasuries in the second half of 2016. This period equates to 4pm on the clock above.

We have been experiencing stage three – the unwinding of US monetary policy (8pm on the clock) – since the beginning of this year, as the tightening of US-dollar liquidity causes stress in emerging-market countries exposed to US borrowing. Stage four, at 9pm on the clock, is the point at which US Treasuries rally and credit sells off as the economic outlook deteriorates. At this stage, we think high-yield bonds (and probably equity markets) are likely to be in decline on the negative outlook.

Our best guess is that this could occur in the fourth quarter of 2018 as the market becomes concerned about 2019 economic growth forecasts, and is able to make an educated guess as to when the Fed will stop raising rates. As the clock shows, the tightening cycle is gradual, but eventually there will be a price to pay for assets that have run ahead of growth.

Paul Brain – head of fixed income. Newton Investment Management, a BNY Mellon company

Our current macro view is that bond markets are in the middle of a transition year. This is owing to the gradual US monetary tightening process currently underway, which has a negative impact on different sectors of the bond market at different stages in the economic cycle. First to feel the negative impact of the tightening were developed-world government bonds, … read more

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Taking charge: How battery technology advances could fuel a new boom in electric transport

As the electric and autonomous vehicles markets evolve, significant advances are being made in battery technology and the race is now on to build battery packs that can compete on cost with the internal combustion engine.

There is a lot of debate about how much battery packs of the future will cost with a target of US$100 per kilowatt-hour often held up as the figure which will make them competitive with conventional petrol and diesel fuelled engines. Given recent technological advances, that could be achievable by 2022-23.

Battery costs have already been dropping at about 15% per year over the past decade. Scale manufacturing and adjustments in the way chemicals and technology are applied in battery construction are also helping to improve battery energy density and the range they allow electric vehicles to travel.

Major tyre manufacturers are also addressing the challenges set by the weight of EVs by developing better tyres specifically designed for them. Because of the sheer weight and the higher torque of electric battery driven vehicles, their wheels do need stronger tyres with lower rolling resistance. Tyres will need to improve over time to support this market.

Frank Goguen and Barry Mills, senior research analysts. The Boston Company, a brand of BNY Mellon Asset Management North America Corporation

As the electric and autonomous vehicles markets evolve, significant advances are being made in battery technology and the race is now on to build battery packs that can compete on cost with the internal combustion engine. There is a lot of debate about how much battery packs of the future will cost with a target of US$100 per kilowatt-hour often … read more

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The BBB conundrum: an accident waiting to happen?

The composition of the US corporate investment grade (IG) market has undergone a dramatic transformation over the last decade. A boom in debt-fuelled M&A and share repurchase activity has contributed to an increase in leverage and an explosion in BBB-rated US IG corporate debt. There are signs that while downgrades have happened, credit rating agencies have been arguably too lenient in some cases, placing too much faith in the ability/desire of companies to de-lever within a target timeframe.

However, the general trend of increased leverage is consistent with a strengthening economic backdrop. The US economy remains in the midst of a protracted economic expansion that began almost a decade ago and, should it continue into summer 2019, will become the longest expansion in its history. Along with the recent tax reforms, this presents a very favourable environment for corporate America. The tax reforms should lead to an improvement in corporates’ free cash flow, which would enable them to manage higher leverage burdens; and the now higher after-tax cost of debt makes it less attractive from an issuer’s perspective. This should pour some cold water on opportunistic debt issuance. Along with still-easy monetary policy, an economy at full employment and the Federal Reserve’s preferred measure of inflation hitting 2% for the first time in six years, and the increase in corporate leverage makes more sense.

We would also note that valuations of BBB-rated debt still appear attractive in the context of historical loss rates. That said, if the credit cycle turns and companies do not sufficiently delever, rating agencies may be forced to downgrade some of these large-cap companies to high yield. We therefore believe security selection has become ever-more important.

Peter Bentley – head of UK and global credit. Insight Investment, a BNY Mellon company

The composition of the US corporate investment grade (IG) market has undergone a dramatic transformation over the last decade. A boom in debt-fuelled M&A and share repurchase activity has contributed to an increase in leverage and an explosion in BBB-rated US IG corporate debt. There are signs that while downgrades have happened, credit rating agencies have been arguably too lenient … read more

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Emerging market sell-off: an untimely exit?

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; our global macro outlook actually supports the asset class.

We expect the main external drivers lead to a reversal of recent trends and bolster EM assets such as local currency debt. While US rates will likely continue moving a bit higher, the bulk of expected Federal Reserve hikes are already priced in forward curves. A relative healthy global growth outlook continues to support commodity prices, an obvious boon to many commodity exporters. Finally, we believe some fundamental drivers for US dollar depreciation remain intact. We also think the dollar is expensive, particularly when considering mounting twin external and fiscal deficits. As the dollar begins to slide, which we expect, it will create a tailwind for the asset class. While we may have to be more patient, we think the asset class will recover and likely post notable returns.

Federico Garcia Zamora – portfolio manager. Standish, BNY Mellon Asset Management North America

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; … read more

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Green thinking: A future growth market for bonds?

Green bonds offer investors looking for exposure to sustainable investments a chance to invest in the ‘E’ (environmental element) of their environmental, social and governance (ESG) remit. They allow investors to help aid the transition to a low-carbon world by lending money that will be used for specific green projects.

Historically, exposure to these types of projects was through higher-risk and less-liquid project-finance debt. Standard ‘use-of-proceeds’ green bonds benefit from being backed by the underlying credit rating of the issuer, thereby lowering the specific project risk and thus overall credit risk. The cash flows funding the coupons and principal can originate from non-green operations, and the bond can still be considered ‘green’.

Evidence suggests that green bonds price at a similar spread to non-green bonds, thereby encouraging investors who do not have specific green mandates to consider investing in them, but the market remains relatively niche.

The real boost that the asset class needs will come when companies from a wider range of industries and geographies are encouraged to enter the market, which will increase liquidity. Countries issuing green bonds may help lead by example.

The fact that green bonds are becoming higher profile leads us to expect that the market structure will continue to improve over time. However, if the market is to continue to grow strongly, it will need greater diversification across credit rating, sector and geography in order to improve liquidity, and a globally agreed means of assessing and evaluating individual bonds.

Scott Freedman – analyst and portfolio manager fixed income team. Newton Investment, a BNY Mellon company.

Green bonds offer investors looking for exposure to sustainable investments a chance to invest in the ‘E’ (environmental element) of their environmental, social and governance (ESG) remit. They allow investors to help aid the transition to a low-carbon world by lending money that will be used for specific green projects. Historically, exposure to these types of projects was through higher-risk … read more

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Measure for measure: Putting the emerging market debt sell-off in context

Emerging market debt (EMD) has had challenging year-to-date performance, and investors are questioning whether this is merely a performance correction after a strong two-year spell, or the start of something bigger. There are some similarities between the current sell-off and 2013’s ‘taper tantrum’, with both influenced to an extent by Federal Reserve (Fed) policy normalisation. If this serves as a useful point of reference, much of the sell-off has already likely materialised. Chief among investor concerns are two key global macro risks with uncertain outcomes – policy normalisation and trade protectionism. This backdrop of global macro uncertainty has intensified the focus on emerging market (EM) vulnerabilities. However, technicals rather than fundamentals have exacerbated this sell-off, with a big unwind of cross-over investor positioning. Relative to 2013, we believe EMs are in a fundamentally stronger position in aggregate. The dislocation created as a result of the indiscriminate selling may also create new investment opportunities for investors able to adopt a flexible approach.

Colm McDonagh – head of Emerging Market Fixed Income. Insight Investment, a BNY Mellon company

Emerging market debt (EMD) has had challenging year-to-date performance, and investors are questioning whether this is merely a performance correction after a strong two-year spell, or the start of something bigger. There are some similarities between the current sell-off and 2013’s ‘taper tantrum’, with both influenced to an extent by Federal Reserve (Fed) policy normalisation. If this serves as a … read more

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Trouble ahead? Tensions rise in US/China trade dispute

This month saw the imposition of 25% US tariffs on $34bn of imports from China, with US duties on another $16bn of Chinese goods to be added following a consultation period. As yet, initial direct economic impact from these tariffs appears minimal. Metal exports to the US are less than 3% of total exports even for Canada and Mexico, while for China, the latest levies are expected to knock only c.0.1-0.2% off GDP growth. However, Trump’s threat of tariffs on an additional $200bn of Chinese imports could have more material consequences for growth and ‘risk’ appetite.

The US and China are predominantly domestically driven economies (exports are only 10% of GDP in the US and 20% of GDP in China), but for China, this exogenous headwind compounds the policy induced economic slowdown attributable to Beijing’s deleveraging focus. Moreover, while China’s manufacturing PMIs continue to reflect growth, new export PMIs pointed to weaker trade momentum even before the latest round of tariffs. Beijing’s policymakers have begun to respond, with the People’s Bank of China (PBoC) offering rhetorical support to the renminbi, and recent targeted reserve requirement ratio cuts for major banks indicating a more nuanced approach to deleveraging.

US-China tensions (both economic and geopolitical) are likely to become a more permanent feature of the investment backdrop, as the market is now beginning to price. Despite last month reducing its sectoral “negative list”, China remains particularly restrictive and selective when it comes to foreign direct investment and President Xi’s flagship “Made in China 2025” policy appears to have piqued both sides of the US political establishment to the limitations of “constructive engagement” and the challenge China poses.

Trevor Holder – portfolio manager. Newton, a BNY Mellon company

This month saw the imposition of 25% US tariffs on $34bn of imports from China, with US duties on another $16bn of Chinese goods to be added following a consultation period. As yet, initial direct economic impact from these tariffs appears minimal. Metal exports to the US are less than 3% of total exports even for Canada and Mexico, while … read more

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Could a ridesharing revolution boost investment prospects?

While the comprehensive introduction of rideshare systems could take years to develop, we anticipate significant progress will be made by 2020 to 2021, at which stage we believe people will be far more aware of the importance of this sector. Looking ahead, people in cities are less likely to buy a car if there is a good transport service, and we are not alone in believing the world is moving toward the wider use of robo-taxis and automated vehicles.

Cities with poor public transportation might see ridesharing as a great supplement to public transport. Ridesharing makes a lot sense in cities with poor public transport, and shared mobility also holds broad appeal in global markets such as China. Many people living in cities are also realising that owning a car is a wasted resource, as it spends most of its time parked and the rest of its time contributing to traffic congestion.

In many ways ridesharing is little different to sitting next to strangers on a subway train or bus and in-car security cameras could bring an added level of reassurance to passengers. Younger generations are already embracing the ridesharing trend and, over time, I expect many more people will become comfortable with it as well.

Barry Mills – senior research analyst. The Boston Company, part of BNY Mellon Asset Management North America.

While the comprehensive introduction of rideshare systems could take years to develop, we anticipate significant progress will be made by 2020 to 2021, at which stage we believe people will be far more aware of the importance of this sector. Looking ahead, people in cities are less likely to buy a car if there is a good transport service, and … read more

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A healthier future? How current spending patterns could point the way

Are we headed for a more health conscious future? Current spending patterns – and especially those of ‘generation Z’ consumers – appear to suggest so.

According to Morgan Stanley, spending on sports apparel rose from US$199.1m in 2009 to US$314.1m in 2017 and is projected to reach US$365.2m by 2020. However, this is just a small segment of the wellness and fitness industry, which in the UK alone is estimated to reach a value of £22.8bn by 2020, according to Statisa. Gym membership is also on the rise. Figures from The Leisure Database Company suggest one in seven of people in the UK now regularly work out.

We believe food consumption habits are another leading indicator for future health spend. Fresh foods such as salads and juices are taking the place of canned and refrigerated goods in the shopping baskets of young consumers. Data from Barclay’s suggests Generation Z consumers are buying 57% more tofu and 550% more dairy-free milk than older cohorts.

Meanwhile, pharmaceutical companies are also beginning to get in on the game: over-the-counter medication and health supplements continue to gain traction as consumers demonstrate a preference for preventative healthcare over traditional prescriptions.

Amy Chamberlain and Stephen Rowntree – global analysts. Newton, a BNY Mellon company

Are we headed for a more health conscious future? Current spending patterns – and especially those of ‘generation Z’ consumers – appear to suggest so. According to Morgan Stanley, spending on sports apparel rose from US$199.1m in 2009 to US$314.1m in 2017 and is projected to reach US$365.2m by 2020. However, this is just a small segment of the wellness … read more

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All hail our algorithmic overlords?

Artificial intelligence (AI) is frequently touted as having the potential to revolutionise every aspect of our daily lives from work to leisure time; commuting to healthcare. Less optimistically, though, luminaries such as Elon Musk among many others have drawn attention to the possible dangers of AI: that by creating the singularity we risk ‘summoning a demon’ that ultimately consigns humanity to oblivion.

We take a more optimistic view, noting that while emerging technologies have often given rise to scare stories about their impact on people’s health and behaviour their benefits have usually outweighed the drawbacks.

For now – and even though it’s still in its infancy – we can highlight how effective AI has been in the fields of healthcare diagnostics, medicine prescriptions, and air travel. For the future, we believe AI is likely to give companies a second wind when it comes to productivity, allowing them to be more efficient, better, faster and actually quite creative in how they transform their offerings.

This in turn should improve growth and therefore, hopefully, generate new kinds of jobs. Far from creating a techno-apocalypse I think AI has the power to transform the world for the better and not for the worse.

April LaRusse – Fixed Income product specialist. Insight Investment, a BNY Mellon company

Artificial intelligence (AI) is frequently touted as having the potential to revolutionise every aspect of our daily lives from work to leisure time; commuting to healthcare. Less optimistically, though, luminaries such as Elon Musk among many others have drawn attention to the possible dangers of AI: that by creating the singularity we risk ‘summoning a demon’ that ultimately consigns humanity … read more

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