07.07.17

Snapshots is trying to stay cool in the unusually hot London weather and it looks as though the markets are struggling to stay cool too

Co-ordinated unwinding

This is because global yields are still reeling from the aftershocks of last week’s central bank messaging.  This is now feeding into the equity markets and credit spreads.  The obvious risk here is that Mx Market (yes that is a deliberate gender neutral prefix) over-reacts and over-discounts what ze (another gender neutral prefix) perceives as co-ordinated central bank unwinding of loose policies. This is compounded by fears of risk parity strategies getting caught out in this correlated volatility.  We are concerned and watching the market very closely.

Petrol horses

The car maker Volvo has stated that it expects 100% of its car production to be electric or hybrid by 2019.  China has upheld electric car quotas of 8% of sales for next year despite protests from car manufacturers.  Conversations in the office with colleagues looking to buy a car all revolve around EVs.  It feels like the EV revolution is gathering momentum and initial adoption forecasts may need to be revised forward.  The disruption to supply chains and ancillary services (e.g. powertrains and petrol forecourt businesses) will be significant.  Creative destruction will gather pace and a new generation of suppliers and service companies will grow and become the new capital consumers.

HY valuations and convexity

We are religious readers of James Grant’s Interest Rate Observer.  In his recent missives on the market he points out that the BAML HY Index is now returning 2.6% on a Yield to Worse basis.  This is less than the Eurostoxx 50 dividend yield of 3.3% and is the first time in history this has occurred.

We have noted a number of times that large parts of the high yield market trade with negative convexity.  This is in contrast to the bank capital market where structures have floating step-ups on call dates.  This is also why we continue to favour banks over corporates in the liquid credit markets.

Finally, we note that Bank of England staff are on strike over pay.  This is symbolic of the growing wage pressures in the UK and we are thinking about the effect this could have on median and aggregate wages in the economy.

By Asif Godall
Deputy CIO