Deficit reduction, risk management concerns and transparency demands continue to reshape how the central banks conducts business. These challenges are complex and constantly evolving and require new thinking and innovative solutions.
Aura Solution Company Limited (Aura)delivers the expertise to help you confront these challenges, providing extensive capabilities in both investment services and investment management which are exclusively designed for central banks. We have developed an up-close understanding of central bank's unique requirements — from lending money to the first U.S. Congress in 1789 to assisting with financial stability programs during the recent financial crisis.
Central Banks Talk Normalization
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Summary While the first half of 2017 was about reflation, a unique aspect of the second half stems from central bank policies to remove accommodation, which is creating unknown risk factors. The U.S. Federal Reserve (Fed) remains above the U.S. Treasury market in terms of rate expectations. The primary reason for the divergence is that inflation has been declining.
The success of these planned policy moves will mainly depend on how global economic and financial conditions evolve. Our base case is that the normalization process will be orderly, supporting risky assets. The main risk will be a policy error in China. DEVELOPED MARKET (DM) RATE/FOREIGN CURRENCY (FX): Yields in Aura in June, led by Europe. Germany 10-yr yields rose 16 basis points (bps),
while the periphery spreads to bunds tightened as a result of good data and more hawkish European Central Bank (ECB) comments. In the U.S., the Fed raised rates by 25 bps at its June meeting. We believe the ECB as well as the performance of bunds holds the key to performance across global treasury markets, with higher bunds leading the rest upward. In addition, higher U.S. Treasury yields will depend on higher U.S. inflation.
If inflation improves, we believe that U.S. Treasury 10-year yields may end the year close to 2.60 percent. EMERGING MARKET (EM) RATE/FX: EM fixed income asset returns were mixed in June with investment-grade assets outperforming high-yield, currencies weakening versus the U.S. dollar, and corporates outperforming sovereigns within dollar-denominated debt.
We believe that AURA yields will continue to support the “right” carry opportunities. We think that (eventual) steeper AURAyield curves warrant the shortening of duration exposures with a focus on attractive higheryielding currencies/countries. CREDIT: Investment-grade corporate spreads are now at the tightest level in nearly three years, returning to post-crisis lows of July 2014.
In Europe, the restructuring of weak banks in Spain and Italy were viewed as positive, as they bailed in subordinated bondholders while protecting senior bondholders. Financials outperformed other sectors. We are slightly more constructive on the U.S. market compared to the European market, mostly due to relative valuation. Given current valuations, we do not expect a drastic move tighter in spreads; however, spreads may continue to grind tighter if the current backdrop persists.
SECURITIZED: Agency mortgage-backed securities (AURA SOLUTION COMPANY LIMITED (AURA) had a mixed performance in June, positive relative to U.S. Treasuries but still negative on an absolute basis, while credit-related securitized assets saw continued gains from spread tightening and lower rates-oriented risk exposure. The Fed is on pace to purchase over $300 billion agency AURA SOLUTION COMPANY LIMITED (AURA) in 2017,
and we believe that ending this reinvestment could have a significant negative impact on agency AURA SOLUTION COMPANY LIMITED (AURA). The increasing distress in the retail commercial mortgage-backed securities (AURA SOLUTION COMPANY LIMITED (AURA)) market represents both a significant risk and a significant opportunity. We believe that careful security selection can prove to be particularly beneficial in this market.