bond market outlook for the year ahead€¦ · june 2018 franck motte . global head of euro rates ....

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June 2018

Franck Motte Global Head of Euro Rates

Bond market outlook for the year ahead

This material has been prepared by a member of the sales and trading department of HSBC France (“HSBC”) and not by HSBC’s Research Department. Any recommendations in this material are based on the individual opinions of the author and may differ from the opinions expressed by other HSBC divisions or entities, including its research department. Not for Distribution to US Clients

For Distribution to Professional and Eligible Counterparties

Please see important disclaimer at the end of this document

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Topics

Global macro

Tariffs and trade wars

ECB APP and PSPP dynamics: past and future

The importance of PSPP purchases on the curve

Italy developments

Rates market

Outlook

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Global macro

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Global macro

Real GDP

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2012 2013 2014 2015 2016 2017 2018f 2019f

Real

GDP

(YoY

, %)

Global EM DM

Inflation

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017 2018f 2019f

Infla

tion

(YoY

, %)

Global EM DM

Source: HSBC Global Research (incl. forecasts) Source: HSBC Global Research (incl. forecasts)

Global expansion, monetary policy and potential inflection point US fiscal stimulus provides short-term boost, but with longer-term risks. Meanwhile, growth in the Euro-area and Japan have seemingly peaked. EM to see solid

growth, but China demand mix is changing and will have varying degree of global impact Expecting a total of three rate hikes this year, but slower pace in 2019 as tightening financial conditions begin to be felt. ECB is seen as terminating its QE

programme by end of 2018; however, only one 15bp deposit rate rise in 2019. In Japan, the BoJ’s yield-curve control is likely to remain in place; whereas elsewhere EM faces different degrees of monetary independence

Slower growth, rising oil prices, higher inflation and/or faster tightening are all risks, but trade wars bigger. Initial impact seen via asset markets and business sentiment, but then weaker world trade and therefore GDP growth would be deflationary

Source: HSBC Global Research

Global economic outlook

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Global macro

Various global OECD leading indicators (normalized) OECD LEIs for Euro-area and its main economies

Source: HSBC, Bloomberg Source: HSBC, Bloomberg

Global macro environment retains a positive outlook; however, some diverge this year Period since 2016 has seen significant positive momentum for leading indicators, especially in US and Euro-area Within large economies, China and UK have exhibited a negative turn, although this has been driven primarily by domestic issues Of interest is the seeming shift in momentum to the positive for China this year, notwithstanding on-going concern over debt levels 2018 has seen some slowdown in momentum for the Euro-zone, which has been consistent amongst the main economies Notable has been the resilience shown by the leading indicators in Spain through past few years Impact of strengthened Euro currency has been a likely factor


Positive growth momentum highlighted in LEIs, especially in US

97.0

97.5

98.0

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12 13 14 15 16 17 18OEC

D Le

adin

g In

dica

tors

CLI

Nor

mal

ised

SA In

dex

USA Euro Area China

Japan UK OECD Total

97.0

97.5

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12 13 14 15 16 17 18OEC

D Le

adin

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SA In

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Euro Area Germany France

Italy Spain Netherlands

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Global macro

With the EUR-USD rate rising to above 1.25, export-based economies, such as Germany, saw a pull-back in Ifo index

Change in exports (goods and services) following a 1%ppt increase in the exchange rate1

Source: HSBC, Bloomberg Source: HSBC Research estimates, Eurostat

Significant rally in the euro since 2016 has reached important levels Some of the softness exhibited in the early 2018 Euro-area economic data is associated with the strength of the currency Exports are impacted by a high-enough strength of the euro, and the latest data shows a weakening Ifo index for Germany HSBC Global Research shows that the time lag for the impact of a 1%ppt increase in the euro is 5-7 quarters


Impact of a strengthening euro on the export sector

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Jan-16 Jul-16 Jan-17 Jul-17 Jan-18

ZEW

Ger

man

y in

dex

EUR-

USD

EURUSD Spot Exchange Rate - Price of 1 EUR in USD

Ifo Pan Germany Business Climate

-1.2

-1.0

-0.8

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1 2 3 4 5 6 7 8 9 10

(%pp

t)

Time lag (quarters)Eurozone Germany France

Italy Spain

Notes: 1. HSBC Research estimates based on an Error Correction Model. The chart shows the impact X number of quarters after the shock. The positive initial reaction for some countries might be due to the source of the shock; for example,

positive demand shock could boost FX and intra Euro-area exports

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Global macro

Trade-weighted euro and non-energy industrial goods inflation

Euro-area core inflation has barely moved since QE started

Source: HSBC Global Research calculations, Eurostat Source: HSBC, Eurostat

Has the recent strength in the euro started to weigh on Euro-area inflation? Lagged relationship is suggestive of a medium-term dampening effect on inflation in the Euro-area

While headline inflation has moved higher during QE, core Euro-area has remained constant The core inflation measure has in fact been hovering around close to the 1% level since 2014

The effect of the currency on Euro-area inflation

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Current account balance, 2018 US tariffs are low by global standards

Source: Thomson Reuters Datastream

Source: WTO, HSBC Global Research (‘Trade Wars’, Janet Henry and James Pomeroy, 13 March 2018)

Countries with large external deficits are vulnerable to trade actions

-8 -4 0 4 8 12 16 20

SingaporeTaiwan

SwitzerlandThailand

GermanyNorway

KoreaSweden

Saudi ArabiaJapan

RussiaMalaysia

ItalyNigeria

Hong KongChinaSpainBrazil

PhilippinesAustralia

ChileFrancePoland

IndonesiaMexico

IndiaCanada

USNew ZealandSouth Africa

ColombiaUK

ArgentinaTurkey

(%GDP)

No data0 - 3%3 - 6%6 - 9%

9 - 12%12 - 15%

> 15%

Key

Simple average applied most favoured nation tariff

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History of ECB APP programmes, with redemption amounts

Breakdown of ECB APP purchases and impact of redemptions

Source: HSBC, ECB (incl. redemption forecasts), Bloomberg Source: HSBC (incl. redemption estimates2), ECB, Bloomberg

While the ECB QE programme has been reduced, redemptions are increasing ECB’s APP programme is currently at €30bn per month to September, and €15bn thereafter till December 2018 However, an issue of growing importance is the redemptions, especially within the PSPP… …in fact, the week of 20 April 2018 saw purchases be entirely a function of re-investment (indeed net purchases were negative)

Evolution and the increasing importance of redemptions

Notes: 2. By cross-referencing the monthly data on PSPP flow, with the ECB’s weekly financial statement and the list of lending ISINs provided by the ECB and NCBs, it is possible to confirm relatively accurately around 13.8% of the actual

redemptions; whereas for the latter some arbitrary assumption are made to ‘distribute’ the published redemption amounts to each maturing ISIN

-10

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15 16 17 18 19Mon

thly

APP

pur

chas

es a

nd fu

ture

rede

mpt

ions

(€

bn)

PSPP ABSPP CBPP3CSPP APP Purchases PSPP redemptionABSPP redemption CBPP3 redemption CSPP redemption

-202468

1012141618

24-M

ar-1

714

-Apr

-17

5-M

ay-1

726

-May

-17

16-Ju

n-17

7-Ju

l-17

28-Ju

l-17

18-A

ug-1

78-

Sep-

1729

-Sep

-17

20-O

ct-1

710

-Nov

-17

1-De

c-17

22-D

ec-1

712

-Jan-

182-

Feb-

1823

-Feb

-18

16-M

ar-1

86-

Apr-

1827

-Apr

-18

18-M

ay-1

8

(€bn

)

Weekly net of redemption changes in ECBCPSPP Index

Implied redemption re-investments

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Redemptions have moved to around 50+% of potential Redemptions also likely to cause deviations from key

Source: HSBC, ECB, Bloomberg Source: HSBC (incl. redemption estimates3), ECB, Bloomberg

For most months, PSPP redemption amounts have become over 50% of potential holdings Comparing ECB’s PSPP redemption path with a calculation of the maximum allowable purchase per maturing security… …based on ECB/NCB lending ISINs and PSPP purchasing limits, shows that the redemptions have climbed to 50+% of potential This is especially from March 2018, predominantly due to the ECB’s APP rule changes introduced in January 2017 Redemptions also driver for monthly deviation from Capital Key Large re-investment in German bond caused ‘miss’ on March/April 2018 net PSPP German purchases

PSPP redemptions are sizeable to potential; Capital key deviations



0%

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Mar-17 Sep-17 Mar-18 Sep-18 Mar-19

ECB redemptions as %age of potential total redmeptions (adjusted forlimits, incl. CACS)

-5%-4%-3%-2%-1%0%1%2%3%4%5%6%

Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18Devi

atio

n fr

om C

apita

l Key

bas

is -e

x Gr

eece

and

Cy

prus

(%pp

t)

GE ES FI FR IRIT NL PT SL SV

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PSPP proportion of monthly APP purchase is now below 80%

Reduction in PSPP monthly purchases has not been consistent

Source: HSBC, ECB, Bloomberg Source: HSBC, ECB, Bloomberg

Reduction in monthly APP to €30bn has seen a decline in PSPP to now less than 80% Monthly PSPP purchases have been in €20.7-23.6bn range in 2018, roughly 70-80% of monthly APP Less liquid markets than Sovereigns or Supras provides only a finite amount of flow that can be purchased… …the lower overall APP purchase amount allows for a continuation of that purchase rate, and hence a greater decrease for PSPP A similar narrative can be seen for smaller sovereign markets, such as Portugal, Slovenia, Slovakia, as well as Finland and Ireland

Quarter-end adjustments up to €7bn Adjustments to PSPP at quarter-end, due to amortisation impact, have become sizeable

Reduced monthly APP purchases allow for broadening of buys

-10%

0%

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30%

40%

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80%

90%

100%

15 16 17 18

Prop

ortio

nal b

reak

dow

n by

pro

gram

me

of th

e EC

B AP

P

PSPP ABSPP CBPP3 CSPP

-6

-5

-4

-3

-2

-1

0

1

Aust

ria

Belg

ium

Germ

any

Spai

n

Finl

and

Fran

ce

Irela

nd

Italy

Net

herla

nds

Port

ugal

Slov

enia

Slov

akia

Supr

anat

iona

ls

(€bn

)

Change in monthly purchases (Dec-17 to Mar-18)

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Evolution of implied4 monthly WAM for PSPP Shift in German PSPP monthly implied4 WAM key for curve

Source: HSBC, ECB, Bloomberg Source: HSBC, ECB, Bloomberg

The implied weighted average maturity for each PSPP sector has diverged since 2017 Capacity constraints, especially for the smaller markets, has been the primary reason for divergent paths

German PSPP purchases are key to the shape of the bond yield curve in Euro-area The ECB changes in January 2017, opening the front-end of the curve, allowed for a sharp steepening of 2s/10s This could be key when redemption are preeminent

Implied monthly weighted average maturity of PSPP has been critical

02468

1012141618202224

Mar-15 Mar-16 Mar-17 Mar-18

Impl

ied

mon

thly

wei

ghte

d av

erag

e m

atur

ity (i

n yr

s)

Austria Belgium Germany Spain

Finland France Italy Netherlands

Portugal Slovenia Slovakia Supras

-140

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-120

-110

-100

-90

-80

-70

-60

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-40

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2s/1

0s G

erm

any

(bp)

-re

vers

ed

Impl

ied

mon

thly

wei

ghte

d av

erag

e m

atur

ity (i

n ye

ars)

Germany Germany 2s/10s (forward 2m)

Jan-17: ECB lowered

minimum PSPP purchase maturity to 1y and allowed

sub depo rate



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Italy developments

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Italy developments

5y and 10y BTP-Bund yield spreads Volatility of returns for 1-3y Italy index and including FX


Most recent pick-up in volatility is small by historical standards Widening of 5y and 10y BTP-Bund yield spread has been greater than 2017 episode, but remain less than in Euro-zone crisis Increase in annualised volatility for Italian government bonds has been consistent with what occurred during Euro-zone crisis… …however substantially lower than volatility seen during 1990s, if historical ITL-DEM FX rates included One way of thinking about the evolution of historical volatility from the pre-Euro period is to consider… …the transition of FX volatility into the credit spread (i.e. BTP-Bunds)

Volatility of Italian government bond market, in a historical context

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Italy developments

Daily volumes: Italian sources (MIFID)5 MIFID (post-trade) daily volumes (real-time only)5


Daily volume declined significantly during May, especially on a domestic basis Using merely non-delayed data, daily volumes for the BTP, CCT and CTZ markets fell from a €6-8bn range, down to €2-3bn Meanwhile the other MIFID trade source (i.e. non-domestically focused) have seen a decline as well… …however, the absolute amount of reduction has been less

Italian government bonds volumes declined significantly over May

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1-May 8-May 15-May 22-May 29-May 5-Jun

Volu

mes

repo

rted

-Ita

lian

sour

ces (

€bn)

<1.5y 1.5-3y 3-5y 5-10y 10-15y 15y+

0

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5

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9

1-May 8-May 15-May 22-May 29-May 5-JunVolu

mes

repo

rted

-M

IFID

(pos

t Tra

de S

ourc

es),

Real

time

(€bn

)

<1.5y 1.5-3y 3-5y 5-10y 10-15y 15y+

Notes: 5. Italian government bonds used: BTPS, CCTs and ICTZ, extracted using the MOSB Bloomberg function on 7 June 2018. Italian sources on Bloomberg output include MTS Italia; whereas the MIFID (post-trade) includes MTS

BondVision, Bloomberg and TradeWeb

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Italy developments

Sovereign credit ratings for Italy Calendar schedule for assessments of ratings

Source: HSBC, Bloomberg, Credit Rating Agencies, media websites

Source: HSBC, Markit iBoxx website

Rules for inclusion to Bond Indices Most of the main globally used benchmark bond

indices, such as Markit iBoxx, Bloomberg Barclays, etc. use an investment grade threshold for inclusion, on a sovereign credit ratings basis

Most use an average or ‘two out of three’ approach, where the sovereign requires an investment rating from at least two of the three main credit rating agencies (S&P, Moody’s and Fitch)

Some utilise a main index, for example the S&P, with Moody’s substituted in the event of no ratings from the former

Domestic bond indices, such as the FTSE MTS series, for Italian government bonds, do not have a ratings threshold

Italy has a 2-notch buffer Currently Italy has the same level of rating from all

three agencies

Italy’s sovereign ratings under pressure

Notes: 6. Moody’s put Italy’s sovereign rating on watch-list negative on 25 May 2018

Italy Fitch Moody’s S&P Total

Rating BBB Baa2 (–ve) BBB BBB

Score 9 9 9 9

Italy Fitch Moody’s S&P

Last 16-Mar-18 16-Mar-186 27-Apr-18

Next 31-Aug-18 7-Sep-18 26-Oct-18

Source: HSBC, Bloomberg and various media websites

Fitch Moody's S&P Score Score iBoxx RatingAAA Aaa AAA 1 1 AAAAA+ Aa1 AA+ 2 2AA Aa2 AA 3 3AA- Aa3 AA- 4 4A+ A1 A+ 5 5A A2 A 6 6A- A3 A- 7 7BBB+ Baa1 BBB+ 8 8BBB Baa2 BBB 9 9BBB- Baa3 BBB- 10 10BB+ Ba1 BB+ 11 11BB Ba2 BB 12 12BB- Ba3 BB- 13 13B+ B1 B+ 14 14B B2 B 15 15B- B3 B- 16 16CCC+ Caa1 CCC+ 17 17CCC Caa2 CCC 18 18CCC- Caa3 CCC- 19 19CC Ca CC 20 20 CCC C C 21 21 CD/RD D 22 22 D

CCC

AA

A

BBB

BB

B

Example of rating score for bond index inclusion (Markit iBoxx)

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Rates market

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Rates market

2y and 10y UST yields and 5s/30s curve UST issuance: this fiscal year focus has been on TBills


Continuation of the trend seen for the past couple of years: higher yields, flatter curves Combination of healthy underlying US economy has allowed the Fed to continue its hiking cycle Fiscal trajectory, issuance projections and Fed balance sheet run-down assisting monetary policy in pushing yields higher However, with the near-term focus being an increase in at the front-end (i.e. TBills), the curve has continued to bear-flatten

US Treasury yields and curves

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Rates market

3m USD Libor-OIS widened aggressively this year US swap spread have moved higher; 10y now positive


Theme of US swap spread widening has continued in 2018 At short-end, various factors including increased TBill issuance and effects of reforms has been catalyst for widening Libor-OIS Along the curve, combination of fiscal expansion and bearish yield environment have allowed swap spreads to move positive 30y swap spreads look likely to test the flat level last seen in 2014

Libor-OIS and US swap spreads

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Rates market

History of 5y and 10y UST-Bund yield spread Bund and UST asset swap, in 6m EUR7


UST-Bund 5y and 10y spread has moved to widest levels seen in past few decades On-going Fed tightening, while the ECB has remained in relative easing mode, has allowed for a substantial increase in the spread However, viewed through the prism of a Euro-based investor and the 6m EUR asset swap margin… …for most of the Fed’s rate hiking move it has been the Bund that has held more relative value

Bunds and USTs

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Notes: 7. UST asset swap into 6m EUR does not include adjustment for FX reset

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Rates market

Since Jul-15, two phases of divergence to Bunds vs OATs

Shifts between semi-core and peripheral bond yield in Euro-area


The phases of Bund-OATs, reflecting market pressures The relationship between 10y OAT and Bunds has been an interesting barometer of intra Euro-area bond market pressures Two periods stand-out: French Presidential campaign and its two elections, the bond market sell-off into 2018

Structural shift in the peripheral sector? Ireland has completed its move into the semi-core; Spain almost there (albeit more correlated to BTPs in recent sell-off) Portugal now not the outlier anymore. Italy yield now more than 10y SPGB plus 10y PGB

Intra Euro-area

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Outlook

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Outlook Into the second half of 2018

Geo-politics and global trade interactions: where does the Euro-area go? Will the Fed continue to be hawkish in its interpretation? US politics: mid-terms Are emerging markets something to be concerned about? Focus growing on Brexit end date and impact

Will the euro currency continue to weaken and assist with export led growth? Euro-zone economic momentum enough to sustain a move higher in yields… …aided by end of QE purchases and prospects for ECB tightening Euro-area bond market adjusts to discrete APP redemption flows, as purchase are either tapered or ended Periphery loses assistance of PSPP…wider core-periphery spreads

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Disclaimer

This document is issued by HSBC France (“HSBC”). HSBC is a member of the HSBC Group of companies (“HSBC Group”) and authorised by the Autorité de Contrôle Prudentiel et de Résolution ("ACPR") and the European Central Bank (“ECB”) and regulated by the ACPR and the Autorité des Marchés Financiers (“AMF”).

HSBC has based this document on information obtained from sources it believes to be reliable but which have not been independently verified. Any charts and graphs included are from publicly available sources or proprietary data. Except in the case of fraudulent misrepresentation, no liability is accepted whatsoever for any direct,

indirect or consequential loss arising from the use of this document. HSBC France is under no obligation to keep current the information in this document.

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The information contained in this transmission is intended for the sole use of the recipient and is not for general distribution. The author is a member of the sales and

trading department and not of the research department of HSBC Group. The sales and trading department of HSBC France is engaged in selling and trading in securities to which this transmission relates or is relevant. Accordingly, recipients of this transmission should not regard it as an objective or independent explanation of the matters contained in it. This transmission has not been prepared in accordance with regulatory requirements designed to promote the independence of investment research. Any

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bond market outlook for the year ahead€¦ · june 2018 franck motte . global head of euro rates ....

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