The Daily Prophet: More Proof That Bond Traders Are Charmed

Connecting the dots in global markets.

The bond market has turned in a surprising rally this year, with the benchmark Bloomberg Barclays Global Aggregate Index rising 4.61 percent through Monday. If the year ended today it would be the best annual performance since 2011. If the pace continues through December, it would be the best year since 2003.

That's pretty remarkable considering how many people were betting on a bear market coming into 2016, thinking the new Trump administration's pro-growth policies would spark inflation and much higher interest rates. Well, that hasn't happened and the market may get a fresh bump from the return of one of its biggest buyers. China is prepared to increase its holdings of U.S. Treasuries after cutting them by about $200 billion over the course of last year, as officials believe the assets have become more attractive than other sovereign debt and as the yuan stabilizes. Signs of renewed appetite from the biggest foreign owner of Treasuries after Japan may help cushion the $14 trillion Treasuries market as the Federal Reserve debates unwinding its massive bond portfolio.

The Fed is widely expected to raise borrowing costs next week, narrowing the rate gap between China and the U.S. and making American assets more attractive. That buying “may pick up some of the slack if/when the Fed decides to let some of their holdings run off,” Anthony Cronin, who trades Treasuries for Societe Generale in London, said in an email. People familiar with the situation who asked not to be identified because they aren’t authorized to comment on the matter publicly didn’t specify the exact circumstances under which China would make more purchases, according to Bloomberg News' Steven Yang.

The S&P 500 just posted a third straight quarter of year-over-year earnings growth. But in the shadow of the rebound is a trend that has been worsening for more than two years: a rising number of profitless companies, according to Bloomberg News' Oliver Renick. About 10 percent of stocks in the benchmark gauge have posted losses in the last 12 months, an uncharacteristically large portion that has no precedent since 2010, according to data compiled by Bloomberg. What’s to blame? Energy companies are a culprit, unsurprisingly. Of bigger concern are technology and consumer stocks that have crept onto the list. Overall, the 51 companies lost $55 billion over the last year. When the market peaked in 2007, the figure was $22 billion. Trailing 12-month earnings in the S&P 500 total about $986 billion, or $113 a share, just below an all-time high reached in 2014. Take out the companies losing money and the total hits $1.04 trillion, or $117, the highest ever. That $4-a-share gap is the widest since 2011, a year when the S&P 500 did nothing in terms of returns.

Given all the angst over the global state of affairs, it's no wonder that the yen is in demand. Japan's currency strengthened beyond the key 110 to the dollar level all the way to 109.23 from as weak as 114.37 last month. A traditional haven in times of stress (largely because of a sizable current-account surplus that doesn’t make the nation reliant on foreign capital), Japan’s currency has been strengthening all year. There are other forces at work as well. The strategists at Brown Brothers Harriman say yield differentials are also boosting the yen, as the shrinking gap between 10-year Japanese government bonds and U.S. Treasuries gives less of an incentive for Japanese investors to move their money overseas. Also, the 0.5 percent year-over-year increase in Japan's cash wages for April matches the highs seen in the fourth quarter, raising optimism that consumption may rise and lift the economy. On Sunday the World Bank raised its outlook for Japanese economic growth this year to 1.5 percent from the 0.9 percent it forecast six months ago, as stronger external demand raises exports and the economy benefits from accommodative monetary and fiscal policy.

Fitting in with the risk-aversion theme, the price of gold keeps rising steadily. It reached its highest in almost six months as a sagging dollar, concern over the U.K. elections and rising tensions in the Middle East increased demand for the metal as a store of value. "Gold is on everyone's mind, and we do think that it has a lot more room to run," said Naeem Aslam, the chief market analyst at Think Markets U.K. Ltd. It won't be long before folks start building vaults to house the precious metal as demand grows. Wait -- that's already happening! From safety-deposit boxes in leafy west London to high-security facilities housing gold and silver in Frankfurt, companies that store valuables are expanding to meet demand, according to Bloomberg News's Eddie Van Der Walt and Thomas Seal. China, the world’s biggest gold market, may boost imports through Hong Kong by about half this year as local investors seek to protect their wealth from currency risks, a slowing property market and volatile stocks, according to the Chinese Gold & Silver Exchange Society. Haywood Cheung, the president of the century-old exchange in Hong Kong that trades physical gold and silver, told Bloomberg News' Ranjeetha Pakiam that mainland China is set to import about 1,000 metric tons from the territory in 2017.

South Africa's economy fell into recession for the first time since 2009. Tensions in the Middle East are on the rise as the Saudis lead a diplomatic isolation of Qatar over that country's financial support for Islamic extremists. The Korean peninsula is as unstable as it's ever been. Brazil is mired in yet another political scandal. Sad times for emerging markets, right? Well, as President Donald Trump might tweet, WRONG! Emerging markets are enjoying steady growth in capital inflows that should top $1 trillion next year for the first time since 2014, the Institute of International Finance said Tuesday. The group expects non-resident inflows to rise to $970 billion in 2017 from $718 billion in 2016, led by China, India and Brazil. Inflows have already been stronger than expected this year as concerns over the impact of Trump’s “America First” trade policy and a faster pace of interest-rate increases by the Federal Reserve faded, said Hung Tran, executive managing director at the IIF. "Medium-term risk of trade friction has decreased significantly," Tran told Bloomberg News' Will Davies and Ben Bartenstein.

With little major data on the global economic calendar, Wednesday will likely be the calm before the storm in markets as investors await "Super Thursday." That's when the U.K. holds a very important general election, the European Central Bank announces its decision on monetary policy and former FBI Director James Comey's testifies to the Senate about investigations of Russian meddling in the U.S. election. That's not to say the calendar is completely devoid of anything of consequence. The Reserve Bank of India is forecast to keep interest rates unchanged at 6.35 percent, while in the U.S., the Energy Information Administration is likely to say that U.S. crude inventories declined for a ninth straight week.

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