From Russia with love

Emerging markets and the European periphery find some respite, meanwhile, it seems like Theresa May has outlasted the England football team amid the political chaos.

Global bond yields were little changed again during the past week with market attention (in London at least) more distracted by footballing matters. However, in a week where trade worries have continued to escalate with the US Administration publishing a list of US$200 billion of Chinese imports on which they may look to charge tariffs, it almost feels like a chilly breeze is blowing across the landscape, even if conditions are largely sunny. Trump provoking the ire of European leaders at NATO doesn’t really help much either and it is tempting to see Russia as the principal beneficiary of the squabbles. Indeed it seems to have been a good month for Russia all round.

In currency markets, the dollar pushed a bit stronger having traded to the weaker end of the recent range. In Turkey, markets reacted negatively to Erdogan‘s new Cabinet, though more generally it seems in July there has been a bit more stability in emerging markets (EM) than was the case in May or June.

European peripheral markets have also been consolidating recent price action. Greece has been an outperformer following its official sector debt extension agreements, though gains in Greek government bonds have been somewhat limited given worries related to new issuance. This seems ironic since Greece does not need to borrow, yet investment banks’ syndicate desks seem to be trying their best to lobby the Debt Management Office to bring a new deal to the market. In our view, Athens would be better advised to wait for credit ratings to rise and yields to fall before coming back to the market. Greece appears an improving credit story yet for now it remains impacted by the limited number of potential investors who can buy its bonds. In this context, stories that the European Central Bank is looking to conduct its own Debt Sustainability Analysis as a possible precursor to buying Greek bonds could be significant in helping to bring about a virtuous cycle of lower yields, improving credit quality, rating upgrades and increased demand from new investors.

Looking ahead, it is tempting to think that the summer may follow a familiar pattern. A broadly benign macroeconomic and policy backdrop is market supportive, yet political news flow and developments around trade will create headline risk and potential downside. We believe it is appropriate to proceed with some caution as any risk-off episode over the next couple of months could be exacerbated by low levels of liquidity and it seems we are unlikely to have seen the last Vol spike of 2018.

After a few days of uncertainty, it seems like Theresa May has outlasted the England football team, though the Prime Minister’s position remains precarious and we see political risk reaching a climax in the autumn. We have added short risk in UK real yields, on the view that yields of -1.7% in real terms represents a gross mispricing by the market, which would be set to correct very substantially should either Brexit be shelved or fresh elections usher in a Labour government. Meanwhile, at a time when the UK risks being alone in the world, it has been interesting to observe views from other English fans here in Russia, given how positively surprised many have been by the country and its people here. It seems that UK government policy may be letting us down on this front too, and it’s a shame more fans from the UK and around Europe were deterred from travelling to be part of what has been a great tournament. From Russia with love, we can reflect on how close we came in our bid to win the Cup. It turns out it’s not ‘coming home’ but here is to Qatar and 2022!

Mark Dowding, co-head of Developed Markets at BlueBay AM

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