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Michael Baxter

Bull and bear: Are bonds set to crash?

Written by: Michael Baxter on June 6th 2013

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Are bonds set to crash? UK enjoys hat-trick of good news. US sees relief. Eurozone’s weakness not quite as weak. Global economy, manufacturing contraction expansion, surveys say 50/50

Are bonds set to crash?

In the US, the yields on 10 year government bonds have risen from 1.75 on 1 January to 2.14, yesterday. In the UK, they are up too, more so in Japan. Intriguingly, however, bond yields have not gone up as fast in the UK as they have in the US and, in fact, have been paying out lower yields (meaning they were more expansive) than the US equivalent for some time. This may prove, if indeed proof is needed, that QE affects bond prices. In the US, the Fed is dropping hints that QE will come to an end soon. In the UK, Mervyn King has been voting for more QE for most of this year, and there are still expectations that Mark Carney will hit the QE button. So, the story is this: in the US, QE is likely to end; in the UK, QE is likely to be extended. US bonds fall, UK bonds fall, but not so fast.

But a bigger fear relates to emerging market bonds.

Top of the pile for a dangerously exposed bond market is Turkey, making it hard to quantify whether recent sharp falls on the Turkish stock exchange are down to the protests, or fears over QE coming to an end.

Turkey’s main stock market index, the Borsa Istanbul 100, lost some 10 per cent of its value over the last week or so. But then again, it had risen some 50 per cent over the previous six months, and the falls began before the protesters hit the streets. Turkey has a current account deficit worth 6 per cent of its GDP and short term external debt is high. Its gross external financing requirement is now worth 25 per cent of GDD, and has doubled since 2008.

But then again, throughout much of South East Asia, there has been a sharp rise in credit growth over the last few years, leading many to predict the region may see a repeat of the crisis that rocked it so hard in 1997. In Indonesia, for example, credit growth has been rising at 20 per cent year-on-year.

It is just that there are differences between South East Asia today and back in 1997. Take Indonesia as an example. While credit has grown rapidly, total credit is still only worth around 30 per cent of GDP and household debt is only 20 per cent of GDP. These are modest amounts.

It is true that some countries in the area do face potential debt problems, Hong Kong and China are more likely candidates than the likes of Indonesia, the Philippines or Malaysia.

Perhaps it would be more appropriate to look at government debt. It would appear Egypt is the most dangerously exposed, with both high debt and a high primate budget deficit. But Hungary, India, Croatia, the Czech Republic and Ukraine could all be sent over the edge if either growth falls or interest rates rise.

PMIs point upwards

It was good news on the UK, relief from the US and good(ish) news for Europe.

Yesterday saw the latest Purchasing Managers Indices (PMIs), covering services or non-manufacturing in the case of the US, for just about everywhere and for the month of May. Let’s start with the UK, move onto the US, then Europe and then to emerging markets and, indeed, the global economy.

UK enjoys hat-trick of good news

In the UK, it was a hat-trick. Just to remind you any score over 50 is meant to correspond with growth. This week, PMIs for manufacturing, construction and services were all over 50. In the case of manufacturing and services, the index rose from under 50 in the previous month. The composite index rose from 52.1 to 54.3.

Markit., which compiles the UK data in conjunction with CIPS, is now projecting growth to 0.5 per cent in Q2, assuming the PMIs don’t worsen in June, that is.

But that is not the end of the good news. The encouraging bit relates to the more forward indicators. In the case of manufacturing, the sub-index tracking new orders rose. In the case of construction, Markit said, “Looking ahead over the next 12 months, around three times as many construction firms (40 per cent) anticipate a rise in output as those that forecast a reduction (13 per cent). This pointed to an improvement in business confidence since April.” As for services, the index tracking new business expansion rose to its highest level since February 2010.

Apologies if this time seems all bull and no bear, but this time round the news from the PMIs relating to the UK was good, just about all good. Even a sub-index tracking input price inflation in the services sector fell to its lowest level this year.

Let’s move onto the US.

US sees relief
Earlier in the week, the PMI tracking US manufacturing was disappointing. The ISM version of the US manufacturing PMI fell to 49, a four year low. All that good news we have been getting from the US of late suddenly felt a tad like hope of reason.

The PMI, (again produced by ISM) tracking US non-manufacturing rose, however, up from 53.1 to 53.7.

Actually, this is more bear than bull. The Index has been higher than that in eight out of the last nine months.

Together, the two indices suggest the US is growing at an annualised rate of 1.5 per cent in Q2, from 2.4 per cent in Q1. So the US is slowing.

On a slightly more bullish note, Paul Dales, Senior US Economist at Capital Economics, said, “With households’ finances improving and the housing recovery well entrenched, we expect that the retail and construction sectors will support the ISM non-manufacturing index in the coming months. This should offset at least some of any greater drag from the sequestration government spending cuts, which appear to have hit activity in the health and social assistance sector. So for the moment, we’re sticking with our forecast that second-quarter annualised GDP growth will be close to 2.0 per cent.”

Tomorrow will see the next jobs report and markets are putting a good deal of store on this. But worryingly, the PMI index tracking US employment in non-manufacturing fell to a 10 month low, although it was at least consistent with expansion.

Eurozone’s weakness not quite as weak

As for the Euro area, well Markit put it this way: “The downturn in the eurozone economy eased for the second month running in May. Rates of decline eased for both manufacturing production and service sector business activity, reaching 15- and three-month lows respectively.”

Broken down by country, the story looks like this:

Germany         50.2     2-month high

Spain               47.2     23-month high
Italy                 46.6     Unchanged
France             44.6     5-month high

At face value, this all looks pretty encouraging, but just bear in mind only in Germany is the composite index consistent with growth. Chris Williamson, Chief Economist at Markit, said, “The reality is that the region lacks any growth drivers, making it difficult to believe that anything better than a mere stabilisation of economic activity remains unlikely for the foreseeable future.”

Global economy, manufacturing contraction expansion, surveys say 50/50

It was roughly 50/50, with approximately the same number of countries having manufacturing PMIs over 50 as under.

Countries with PMIs tracking manufacturing over 50, and listed in order with the highest reading first were: the USA, Canada, Switzerland, Mexico, Indonesia, Japan, UK, Turkey, South Korea, Brazil, South Africa and Russia.

Countries with manufacturing PMIs under 50 starting with the lowest reading first and moving upwards in order are: Greece, France, Taiwan, Italy, Poland, Spain, Austria, the Netherlands, Vietnam, China, Germany, India and the CzechRepublic.

As for global manufacturing and services combined, this is what Markit had to say: “Output rose in both the manufacturing and service sectors during May, with the sharper rate of expansion signalled at service providers. Service sector business activity has now risen in each month since August 2009, with the latest rate of growth broadly in line with the average for that period. Manufacturing production, meanwhile, increased for the seventh straight month.

“National PMI data painted brighter pictures for the US, Japan, the UK and India. Growth slowdown worries were raised about China, however, as Chinese all-industry output rose at the weakest pace since last October. The eurozone economy also remained in its protracted downturn, despite seeing rates of output contraction ease at manufacturers and service providers,”

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: bond bubble, emerging market bonds, end of QE, Eurozone PMIs, UK economy PMIs, Uk recovery, US slowdown

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