Legg Mason: Good news at last

After years of being dragged down by a weak global outlook, the leading Purchasing Managers Index (PMI) – a key gauge of economic sentiment – rose more than expected in the US, Europe and Japan in October, lifting growth-sensitive sectors such as High Yield,

inflation-linked and Emerging Market (EM) bonds, as well as bank loans. Government bonds stayed mostly flat, with short-term rates rising on expectations of higher rates. Inflation expectations also increased – in Europe, reaching the highest level since June. In the US, the 10-year breakeven rate, or the difference between the nominal and the inflation-adjusted real Treasury yields, rose to 1.7%, the highest since May. The premium that investors pay to hold US High Yield (HY) corporate bonds over Treasuries continued to fall, reaching 453 basis points, the lowest since June 2015. US HY is, so far, the best-performing asset class in 2016, with a gain of 16.5%.

EM investors also continued to accumulate gains, especially those invested in Indonesia, following the country’s sixth rate this year. Oil slightly eased to under US$ 50 per barrel, although market optimism increased after China posted a healthy 6.7% growth in the third quarter, reducing investors’ concerns over an economic hard-landing. Investors’ appetite was not only limited to traditional risk assets: Austria joined the ultra-long maturity bond club, selling a 70-year security.

In peripheral Europe, sovereign bonds were boosted by an end to a 10-month political deadlock in Spain. Volatility in Fixed Income markets fell to almost a two-year low. The Chinese yuan and the British pound, however, continued to slide: the former, as it slips back to a level more associated with its new and slower pace of growth, and the latter, dragged down by Brexit concerns.

On the rise. Fixed Income flows – Vive la difference

The prospect of higher rates, increased inflation and a better economic outlook didn’t deter investors from investing in Fixed Income (FI) securities – but it skewed them towards more alternative, less traditional asset classes.

On the slide. The EM volatility club’s latest member? The British pound

The implied volatility of the British pound has surged to levels (10.5%) traditionally associated with EMs, far from the stability of other traditional reference currencies, such as the Swiss franc (6.2%) or the euro (6.6%).