Annual Bond Market Awards 2018

1 January 2019

Bob Michele picks out the winners, losers, heroes and villains in a year of change on bond markets.

Government Bond of the Year – Italy BTPS 0.05% due 4/15/21. Things were so different back in April. As the Federal Reserve was scrambling to raise rates and run down its balance sheet, Italian debt was enjoying its own mini Renaissance. European growth looked reasonably strong, the euro was weak vs the US dollar, and the European Central Bank’s quantitative easing (QE) programme meant that European government debt would be continuously supported. Italy seized the opportunity and sold EUR 4 billion in debt at a yield of 0.05%. Within six weeks, the bonds had sold off to a yield of 2.80% as the market worried that the new Italian government was headed toward fiscal reflation. Mamma mia! Why didn’t the Italians get off a 10-year maturity instead of a three-year?

Corporate Bond of the Year – Petsmart 7 1/8% due 3/15/23. I suppose any bond could be a dog, but really! Petsmart snacks on Chewy to the tune of USD 3 billion+ and then rolls over and barfs all over the bond holders who were already struggling with the company’s distressed debt. Mostly debt was used for the acquisition, and then a 20% stake was dividended out to its private equity owner before another 15% stake was sent to a non-guarantor subsidiary. So much is packed in here about covenant interpretation and end of credit cycle red flags that even a dog could see red.

Central Bank of the Year – Peoples Bank of China (PBoC). Well, I for one am impressed by their policy response to the tariffs. Rather than sit idly and twiddle their thumbs while the…ahem…“scuffle” was unfolding, they quickly assessed that trade math was against them and responded with broad-based ease. Unintentionally, perhaps, they also managed to get under the skin of President Trump, who watched his own central bank continue to tighten monetary policy as a trade skirmish was evolving. The PBoC has come a long, long way since its pre-crisis days.

Central Banker of the Year – President Donald J. Trump. Snicker at me if you want…but as an investor in assets, why shouldn’t I want monetary policy that will keep the economy chugging along and do so without creating broad-based inflation – other than in the assets I might invest in! And by the way, has anyone noticed what has happened to equities/credit/emerging markets since the start of October? Who knew…

Currency of the Year – Japanese Yen. Started the year at just under 113… finishing the year at exactly the same level. I can’t tell if anything actually happened in Japan this year, or if it simply got lost with all the other stuff going on with Brexit, Italian budgets, US-China trade, quantitative tightening etc… No matter, the importance of the Bank of Japan (BoJ) will be significant this year as the global economy slows, the markets correct and the BoJ is the last source of balance sheet expansion.

Comeback Player of the Year – Volatility. 2017 was soooo boring. Asset prices generally went straight up, and the absence of volatility meant that it was difficult to opportunistically exploit valuation shifts and to differentiate performance from competitors. After trading around 10 most of 2017, the VIX (a measure of equity market volatility) has spent the fourth quarter of 2018 between 20 and 25. Bond market volatility (MOVE) has spiked from 45 to 60. Is everyone having fun now?!

Villain in a Leading Role – Quantitative Tightening (QT). William McChesney Martin would be having a right old guffaw today. When he famously uttered that the Fed’s job was “to take away the punch bowl”, QE and markets drowning in barrels of punch couldn’t have been imagined. Is it just coincidence that the month QE converted to QT saw the beginning of an immense correction in risk assets? When the final chapter on the great monetary experiment is written, I think it will be a painful read. Heck, I’d rather the central banks leave balance sheets where they are today and let the banks grow into them over the next 20 years!

Unsung Hero – Dollar Cash. In an era of QE, ZIRP/NIRP (zero interest rate policy/negative interest rate policy) and rampant asset price inflation, cash was truly trash. Raise official rates for three years and deflate asset prices by running down the central bank balance sheet and, presto-chango, cash is suddenly a legitimate asset class again. If you want to sit out the volatility in the equity markets, or you’re confused whether 3% US Treasury yields are still distorted, you can wait it out in cash at close to a 3% yield.

Most Valuable Player – US Tax Reform. It entered 2018 with a lot of fanfare and was soon dismissed as giving the economy nothing more than a short-term sugar rush. I disagree. I think there are an awful lot of good things being done that warehouse good times for the future. First, companies will have the drop from 35% to 21% tax rates on an annual repetitive basis (at least until there’s a new administration in DC). Combine that with all the capital they repatriated and there is a lot of firepower available. Second, we estimate consumers enjoyed about 60% of the benefits of tax reform. Their balance sheet is as strong as it’s been in decades. Finally, companies took advantage of the ability to contribute to their pension fund in 2018, using the 2017 deduction. A lot of this money went into plans, but is still sitting in cash. Again, another source of stored firepower to come in and support the markets. It’s just hard to imagine a recession in the foreseeable future with tax reform still in the background.

Author’s Note – This year, we have reduced the number of awards from 10 to 9. In an era of fee compression, technology-led efficiency and QT, we are doing our best to lean into any potential unsustainable excesses!

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1 January 2019

Robert Michele

Managing Director and Chief Investment Officer Head of the Global Fixed Income, Currency & Commodities Group

Building stronger fixed income portfolios for the future

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