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Our views 23 August 2021

JP’s Journal – US to the world: mind the gap

5 min read

The focus last week was on China, the US Federal Reserve (Fed), geopolitical concerns, and declining sentiment towards risk assets.

I have written about China several times recently. This reflects the importance of its economy but also the political shift that is going on. The crackdown on big tech continues but it is clear that there are wider social goals. This has implications for the way Chinese business are perceived and adds to the uncertainty about investing in the area. A higher risk premium is justified but we must not lose sight of the economic shift that is happening – we can’t just ignore the region.

A political shift is also happening - the retreat of the US from global leadership. This leadership has provided stability for 70 years; through choice the US is prepared to cede this unchallenged position. Events in Afghanistan illustrate this well. In many areas of the US the retreat gap is being filled by China. The UK, despite pretensions, carries little clout and the EU is unwilling to step up. From a US perspective, a region that is not prepared to pay properly for its own defence merits disdain.

The Fed faces a dilemma: the Delta strain coupled with flagging vaccinations rates is impacting activity, business sentiment is more cautious but inflation is elevated and unemployment is declining. The talk last week was of ‘tapering’ – when will the Fed moderate its $120bn monthly asset purchase programme? It seems to me that recent news has pushed this back a bit.

Commodities were at the fore last week - with a widespread retreat in many prices. Brent Oil moved to $65 a barrel, compared to $76 in early July while iron ore is 30% off its May peak and silver nearly 20%. Commodity based equities were also routed with RIO falling 8% last week and Anglo American by more. Again, China was a big driver with expectations of weaker demand going forwards but concerns about US growth also played a part. 

Cash and government

In the UK, government bonds followed the global direction, with 10-year yields falling from 0.57% to 0.52%. Data was generally downbeat: retail sales fell 2.5% in July, coming in well below consensus expectations and June was revised down as well. Online buying continued to grow but it is surprising that further easing in covid restrictions hasn’t helped ‘in store’ sales. Perhaps we should blame the weather! Whatever the cause data suggests that Q3 will see a larger than expected slowing in GDP growth; this view is supported by recent business survey data.

10-year US rates were volatile, ending at 1.25%, but trading within a 1.22%-1.28% range in the week. A noticeable feature has been the strong performance of longer dated bonds with yields not far off YTD lows. Implied inflation retreated across the board.

Cash rates did not change much but sterling was weak, especially against the US dollar.

Credit

High yield spreads were weak, reflecting the move against risk assets; energy related bonds were especially impacted. My favoured indicator of market moves in high yield showed a 10bps widening, taking spreads back to March levels and 40bps higher than six weeks ago. 

My colleague Stephen Tapley drew my attention to Royal Caribbean (RC) - the US cruise line operator. Last week it announced the early redemption of 40% of its $2.32bn 11.5% five year secured bonds, which were only issued in May 2020, at a level 3 points below the market. How was this possible given that the bonds are not fully callable until June 2022? Well, because the company used equity, that it had previously issued along their path to recovery, to avail of the equity claw provision in the documentation it was able to use approximately $1bn of cash to fund the partial early redemption. At the same time, RC launched a $1bn 5.5% 2025 unsecured bond issue for “General corporate purposes, including the replenishment of capital as a result of the up to 40% redemption of the 11.500% Senior Secured Notes Due 2025”. All of this was spelled out in documentation but it shows the importance of detail and is a good illustration of the massive switch in pricing: moving from secured to unsecured and halving funding costs.

Sentiment in investment grade credit markets moved more negative although indices did not register a big move. It was more of the same: limited issuance and little secondary activity.

Over the last few weeks, it has been good to see more evidence of a return to normality. Football and cricket crowds are back, there are more colleagues in the office and Parliament held a packed emergency debate. On the latter – I wonder how many people felt like me that the UK is struggling to articulate what we want to be on the global stage. Plenty of outrage but no sense of strategic direction.

 

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.