The polar fortunes of Austria and Argentina

Austria and Argentina may be alphabetically close, but economically they are at opposite ends of the spectrum.

Much has been made in recent weeks of the exceptional performance of the 100-year Austrian government bond. Year to date returns have breached 80%; not what initial buyers would have anticipated for a AA+ rated issue. In a parallel universe, the Argentinian 100-year bond has lost 30% in the past week. Bond performance typically lies with the more opaque role of duration and convexity yet, in this instance, the looming Argentinian election is the cause of the decimation in the value of its local financial assets.

What is happening?
Argentinians go to the polls this October to vote for either a continuation of President Macri’s market-friendly (although frugal) orthodox economic policies, or back a return to a more populist approach. Primaries last weekend were effectively a dry run for October’s election (given the mandatory turnout) which resulted in Macri losing by a damning 16%. The now very real prospect of future default that is being priced in is being driven by two factors: (i) the leading opposition candidate Alberto Fernandez served as “Chief of the Cabinet” in 03-08; and his Vice President candidate Fernandez de Kirchner served as President in 07-15 when Argentina last defaulted; and (ii) whether or not a potential Fernandez administration wants to restructure its debt, it may have no choice should a run on the Peso leave the sovereign unable to repay its public debt which is 80% in foreign currency.

Argentina’s precedent for such actions warrants this week’s moves in prices; having defaulted in 2001 and 2014. The last default saw bondholders experience a loss of 60% on their par holding. Losses year-to-date have been significant for holders, but could become worse depending on October’s election outcome and the direction of policy thereafter. There is still time for Macri to regain ground, but for now volatility seems the only certainty.

How much does this matter for global credit?
The figures being discussed are substantial – gross external debt at the end of 2018 was $267bn. However, the spill over risk should lie largely within emerging market (EM) credit. Even within EM I suspect the damage from this episode will be somewhat contained – the damage in Argentina has been induced by domestic politics, as we have also seen to a lesser extent in Turkey, rather than induced by common stress factors like the dollar or commodities.

That this fallout has been contained to date is also indicative of an asset class which has become broader and deeper. There have been 32 sovereign EM debuts in foreign debt markets in the past decade and the concentration of the market has consequently reduced – the top 5 sovereign issuers accounted for 51% of the market value in 2011, but this has reduced to 33% today. Mutual drivers of stress will continue, but indications are that the asset class is less susceptible to contagious domestic crises than it once was.

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US Housing data – a cause for concern?

Housing data is perhaps second only to the US yield curve as a cause for alarm bells to be ringing throughout investment houses over the health of the economy.

Much has already been said of the fortune telling abilities of yield curve inversion. In the US housing sector, data releases toward the end of March showed that growth in new housing starts (and the granting of building permits) has moved into negative territory on a rolling 3 or 6-month average basis. The last time this happened was around the 2007/2008 global financial crisis, where mortgages were key to the collapse.

New Housing Starts & YoY Growth

But the figures themselves do not tell the full story. The fall may well be due to one-off factors undermining data in the past year, or a more general deceleration, rather than a cliff-edge moment. Indeed, activity in the housing sector has been erratic, and therefore a less reliable indicator, for three broad reasons:

  • A return towards trend from the unsustainably high readings in 2018 driven by the boost to housing construction post-2017 natural disasters (where hurricane season was the worst since 2005). The recent weather events in the US, though less destructive than in 2017, were still unusual – as also evidenced by construction payroll figures.
  • An adjustment to the SALT (“State and Local Tax”) deduction changes in the 2017 tax bill, which impacts higher earners. More price adjustments are likely to come before this fully works through the housing sector.
  • The return of mortgage affordability measures to the historical norm (i.e. adjusting to higher interest rates) after being unusually attractive for most of the cycle. The perceived ending of the Fed tightening cycle at a lower interest rate than had been expected should be positive.

There are reasons to believe that building will remain steady rather than fall. The rise in the rate of home ownership to a sustainable level from the post-crisis lows are evidence of a market that has worked off much of the lingering imbalances from the bursting of the housing bubble. This underlying change no doubt helped housing data rise in recent years, until the recent dual pinches of affordability and SALT deductions put the brakes on. Labour market improvements, both in the size of the workforce and their earnings, has also increased the pool of buyers, and mortgage applications are still rising, even if only modestly. Indicators of excess, such as delinquencies, are not sending warning signals either.

The conclusion at present is that the housing market has plateaued because it is adjusting to a combination of factors: the run-up in housing prices for most of this credit cycle; SALT deduction changes which hit states with higher prices and taxes; and some underlying structural/demographic changes.

While the housing sector has lost momentum, there is a way to go before the building cycle has run its course. On the basis of current information, we at Kames would be more inclined to expect a continued growth trend, but with susceptibility to disruption by further price adjustments.

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Year of the Pig

Headlines so far aren’t doing this year’s zodiac much justice; live hog prices have spiked as China battles the repercussions of African swine fever. There is no vaccine for a disease that is highly contagious and fatal to pigs, though thankfully not humans. About 1 million pigs have been culled so far in an effort to try to control the spread.

News regarding the economy has not made for pretty reading either. Figures overnight indicated that year-to-date industrial output marked the slowest start to the year in a decade. Retail sales were similarly moribund compared to recent history, growing at their slowest pace since 2003. Such figures were not wholly unanticipated given China’s well-documented struggles with high debt levels, and increasing concerns over the likely outcome of the protracted US trade negotiations. Other headlines of late have only served to reinforce these concerns; aggregate January and February trade data showed exports and imports fell 5% and 3% respectively, compared to the same period last year. Exports reflect both the impact of US tariff threats and the more general waning of global trade. China’s neighbours are also impacted, with their manufacturing bases sensitive to the appetite of the Chinese consumer.

There is some evidence that the Chinese authorities’ efforts to mitigate the slowdown are having an impact, with bank loans and credit both at record highs in January. Whilst this may renew longer-term fears over the potential for the Chinese authorities to inflate the credit bubble, the rhetoric emanating from the National People’s Congress (which takes place this week in Beijing) continues to be suggestive of a government that remains keen to stimulate, and offset as much as possible, the domestic economic slowdown. The market’s focus will likely continue to be more on the shorter-term growth numbers, rather than what the eventual fall-out will be from a credit bubble bursting down the line.

The health of the Chinese consumer is certainly of greater importance to our core rates markets than in years past. Taking Germany as an example, it is clear that virtually all of the cyclicality of German growth typically comes from exports. In Germany, exports are a c.47% share of GDP, whereas in the US the equivalent figure is c.12%. A healthy Year of the Pig is not just of significance to China, but also to its trading partners.

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