Bourse Securities Ltd
During the first three months of 2012, international growth prospects brightened on signs that the major threats to the global economy were receding. However, these hopes were tempered during second quarter, as investor sentiment deteriorated on the account of Europe’s exacerbating debt crisis and the slowing of key emerging nations. Locally, the bond market remained void of new public bond auctions, while the issuing of Government of Republic T&T zero coupon bonds to Clico policyholders continued during the first half. In this piece, we review the performance of both international and local credit markets before taking a closer look at the prospects for the second half of 2012.
The United States
The United States recovery gained momentum during the first half and while there were some improvements in the country’s manufacturing and housing sectors, the US recovery remained challenged by heightened uncertainties.
For instance, investor sentiment and business spending continue to be adversely affected by government spending cutbacks and uncertainty surrounding the looming ‘fiscal cliff,’ which may result in substantial tax and expenditure reforms.
In its June meeting, the US Federal Reserve noted the economy expanded moderately for the year thus far. However, given the elevated unemployment figures, the monetary authority decided to maintain its highly accommodative stance and keep the target range for the federal funds rate at 0-0.25 per cent through late 2014. Additionally, the Fed decided to extend the duration of its latest stimulus measure colloquially referred to as Operation Twist. This bond purchasing programme which commenced in October 2011, aims at exerting downward pressures on long term interest rates.
Operation Twist involves the Fed issuing shorter maturities and then purchasing an equal amount of longer dated bonds, to extend the average maturity of its holdings and thus lower long term interest rates. The measure will be enforced till the year end. During the first quarter the US economy expanded by 1.90 per cent, below the 2.20 per cent level that was anticipated. Most analysts expect the subdued economic environment will persist in the second half of the year.
In fact, the International Monetary Fund expects the US recovery to remain modest, forecasting a growth rate of 2.00 per cent in 2012 and 2.50 per cent in the following year. However, the international aid agency indicated the country’s outlook was tilted to the downside, as it expects fiscal restraint and weaker global demand would constrain growth. The pick-up in the US economy and improved investor sentiment was reflected to some extent in the credit markets. With first quarter’s increase in confidence, investors began to gravitate to higher yielding ‘riskier’ assets. As such US Treasuries, which had a stellar performance in 2011 (9.92 per cent), rose a modest 2.06 per cent during the first half 2012. US Corporate Bonds experienced a comparable return of 2.44 per cent as indicated by the JP Morgan US Aggregate Total Return Bond Index.
In the European space, economic activity remained depressed, with unemployment at a Euro-era high of 11.1 per cent in May. The Eurozone is poised to experience a mild recession in 2012, with the International Monetary Fund (IMF) forecasting a gross domestic product growth rate of -0.3 per cent. While during the first quarter it seemed the region’s crisis had stabilised following Greece’s debt restructuring, in June, Europe’s debt woes once again resurfaced following Spain’s and Cyprus’ need for financial assistance. Spain will obtain up to 100 billion euro from the EU to recapitalise its banking sector and Cyprus may need up to 2.8 billion euro to support its banks, which suffered from their huge exposure to Greek debt.
Growth in key emerging nations such as China, India and Brazil slowed considerably during the first half 2012. While still maintaining an upward growth trajectory during the first quarter 2012, key emerging nation such as Brazil and India expanded by 0.80 per cent and 5.30 per cent, respectively, on a year-on-year basis as opposed to their 4.24 per cent and 9.2 per cent growth rate during the same period a year ago. This was largely attributable to the spill over effects of Europe’s debt crisis, falling commodity demand and the tardiness of policymakers’ response to the slowing. However, emerging market monetary policymakers have attempted to adopt an accommodative stance to spur economic activity. For instance in 2012, Brazil lowered its benchmark rate on four occasions from 10.5 per cent to 8.5 per cent, and China also reduced its benchmark rate on two occasions to six per cent. Over the past 6 months, with the increase in risk appetites, emerging market bonds rallied and outperformed US Treasuries and corporate bonds. As such, the JP Morgan Emerging Market Total Return Index earned a return of 7.18 per cent year-to-date.
Local fixed income
The local bond market was relatively stagnant during the first half 2012 and was void of any public bond issues. While there was a pick-up in activity in the secondary market, the increase in trades was mostly attributable to intra-company transactions rather than third party trades. During the first six months of the year, the issue of zero coupon bonds to Clico and BAT policy holders continued. As at June 29, the Central Bank indicates $7.6 billion of zero coupon bonds was distributed to bond holders. Of the $7.6 billion bonds issued, roughly 43.42 per cent or some $3.3 billion of bonds distributed was traded on the secondary market. It should be noted these figures do not account for “double counting” arising from the inclusion of subsequent third party trades. The local financial sector continued to exhibit a highly liquid environment. Nevertheless, there was some ‘mopping up’ of excess liquidity within the financial system during the first six months of 2012 due to the actions of the Central Bank. Commercial banks’ excess reserves fell from its $6.5 billion high in March, to $2.2 billion in June 2012. As Figure 2 illustrates, with the decline of excess reserves, short term interest rates inched upwards. 91-day Treasury yields increased to 50 basis points in June from 22 basis points in January, while the longer 182-day yield rose to 47 basis points in May from 28 basis points over the same period.
The global macroeconomic environment remains fraught with uncertainty which acts to dampen investor sentiment and encourage heightened levels of volatility. However, the level of volatility experienced in the fixed income markets has continued to prove less than that of the equity markets. Thus, we continue to encourage investors to consider fixed income products, especially EM bonds which continue to outperform. Locally, the bond market was initially expected to be buoyed by higher levels of activity, as the government was expected to come to the local market to fund around 50 per cent of its budget deficit ($4 billion). However, recent data from the Central Bank indicates that as at the first half of the fiscal year, the government was running a fiscal surplus of $2.8 billion. As such, the level of activity initially expected, may not be realised. With the local economic recovery expected to remain tepid, interest rates are projected to remain depressed in the short- to medium-term.