Monday – Global manufacturing activity (PMI) indices
Tuesday – Eurozone inflation; German unemployment
Wednesday – Global services PMIs; eurozone unemployment and ECB policy decision
Thursday – Bank of England policy decision
Friday – US non-farm payrolls
Japan retakes the low-yield mantle
For a brief period earlier this year, German bunds overtook Japanese government bonds (JGBs) – the epitome of paltry income – as the lowest yielding major government bonds. But as bund yields bounce back, the yen has resumed its slide against other major currencies.
In recent months, we have moved from a negative to a neutral view on the yen. And with other major bond markets offering little additional yield over Japan – an historically unusual state of affairs – this should reduce the pressure on the beleaguered Japanese currency.
After rebounding, German 10-year bund yields are just back over 0.5%, for example, compared to about 0.4% for 10-year JGBs. Such a small difference would have been hard to imagine two years ago, when the Bank of Japan embarked on its latest round of decades-long string of quantitative easing (asset purchasing) aimed at combating deflation.
After more than two years of yen devaluation, the Japanese currency is now trading at its lowest level in more than 40 years in real effective terms (the exchange rate adjusted for inflation against major trading partners).
The euro’s real effective exchange rate has also suffered recently, but the move is modest by comparison – testing 15-year lows. With little in terms of yield to distinguish it from the yen, the euro is still looking vulnerable.
On this basis, the even lower-yielding Swiss franc looks all the more vulnerable. Despite having negative interest rates (also the lowest in the world), its real effective exchange rate has been going up recently.
When you consider the Swiss National Bank’s (SNB) preference for a weaker currency and recent record of intervention, the Swiss franc looks more likely to go down than up from here.
Eurozone bonds stable, equities still attractive
Though bund yields have had a big bounce (prices have dropped) from the previously unthinkable record lows reached earlier this year, bunds are still firmly in the camp of low-paying assets. Our preference within Europe continues to be for the higher risk-adjusted return potential of peripheral eurozone debt.
European Central Bank (ECB) bond-buying and fears of a Greek exit from the eurozone seem to keeping a lid on the rebound in bund yields. In the past week, buyers have come in despite the paucity of these yields, chasing them back below 0.6%, and we don’t think further significant rises are likely from here.
Our view on the outlook for the eurozone economy remains positive, and deflation should be averted. So for longer-term investors, bund yields look unlikely to provide an above-inflation income.
The one potential game-changer to our positive view on Europe would be a disorderly outcome to the negotiations on Greek debt. Our view has been, and remains, that a short-term solution will be reached, easing the pressure to enact structural reforms and renegotiate the country’s debt. It could also erode safe-haven demand for bunds, and boost the attractiveness of other peripheral debt.
European equities have been among the strongest performing major markets this year – up over 20% so far, pushing some markets to all-time highs. But we see potential for further gains. If earnings do rise back towards their longer-term trend then we think Europe’s equities look attractively valued – especially in Italy and Spain.