Weekly Bond Update: What's in store for 2018
- This year is finishing with strong performances by shares and bonds
- As 2017 comes to a close we consider what the trends may be next year
- Three trends may be higher yields, weaker EMs and periphery issues
By Althea Spinozzi
This year is nearing its end and leaving behind a big rally in equities and strong performances by bonds which makes this a timely juncture to consider whether this trend will continue in 2018.
Many things can happen next year, however, I want to discuss three of topics in particular that I believe will be very important for the bond market. I also invite you use the comments section below to write which three events you think may move the market next year. It will be a good chance to pick each others' brains and wish each other a Merry Christmas.
provide opportunities for investors including the Italian election. Photo: Shutterstock
Don’t panic! It is natural that as the Federal Reserve continues with quantitative tightening and interest rate hikes, bond yields go up. Just to put things into context, if we think that the Fed needs to be more aggressive now that the tax bill has passed, it may need to hike interest rates every quarter in 2018. This represents a move of 2%, which should push yields higher even at the long end.
However, if demand for longer maturities continues to be sustained there may be the risk that the shorter part of the Treasury curve is pushed higher faster than the long end, putting more pressure on an already flat curve yield.
Although this remains a risk scenario, I strongly believe that a flat yield curve represents an opportunity for investors to stay short and wait for better opportunities.
2. Emerging countries start to crumble
Watch out for this one. Emerging markets have been a fixed-income darling for quite a long time. After Goldman Sach's Jim O’Neill came out with the BRIC acronym, the MISTs soon followed. However, investors have gone deeper, exploring frontier markets such as the sub-Saharan region.
2017 has seen the issuance of eurobonds for Nigeria, Senegal, Ghana, Gabon and many others. These countries have been able to issue record high amounts of debt. But as the USD continues to be strong and these countries' political situation gets more and more complicated, will they be able to repay their debts?
3. Italian elections in March 2018
The periphery this year has seen Spain dealing with separatist unrest in Catalonia, and although elections are to be held tomorrow it seems that Madrid has things under control. Catalonia has shaken the periphery this year, especially subordinated and higher yielding bonds. However, I believe that next year it is going to be Italy's turn to make things interesting for the periphery. Since Friday, Italy's 10-year bond yields are higher than Portugal's 10-year yields for the first time since January 2010 as investors start to realise Italy is probably going to close the year with the second-slowest economic expansion after Greece compared to regional peers.
Although we are three months away from the Italian elections I believe that investors have not yet realised that this event will be the one that may shake the periphery the most as there is no clear winner in sight and parties will need to form a coalition in order to secure a majority at the elections.
This will be a difficult task because the parties are diverse and there are several points they cannot agree on, thus it will be difficult to govern the country consistently.
Now it’s your turn, what you see in your crystal ball?
— Edited by Gayle Bryant
Althea Spinozzi is a sales trader at Saxo Bank.