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Market Commentary – January 2016

Developed Market Debt

Develped market yield fell sharply across the curve on global growth concerns, low inflation expectations as a result of lower commodity prices and continued anxiety over the Chinese economy. The U.S. manufacturing sector disappointed, and investors tempered rate hike expectations, pushing Treasury yields lower. Japanese government bond yields slipped when BOJ Governor Kuroda surprised markets at the end of the month by introducing negative rates – after denying the possibility just one week prior. In Europe, ECB President Draghi reiterated the central bank’s accomondative stance, and core yields sank while peripheral spreads widened. In the UK, investors moderated Bank of England expectations as Govenor Carney noted, “Now is not yet the time to raise interest rates,” given low inflation and decelerating UK growth.

Credit

Global investment grade credit spreads widened 21 bps in January, alongside broader risk-off sentiment: Oil prices tumbled below $30 and induced sharp sell-offs in global equity markets. Overall, global credit yields rose around 7 bps during the month, and higher overall yields should continue to support more demand for credit relative to supply.

With risk aversion rising across markets, global high yield bonds fell -1.5% in sympathy with stocks (down -5%). Government yields were meaningfully lower in January while speculative grade yields rose, which sent spreads wider by nearly 75 bps to end the month at approximately 720 bps. Both spreads and yields in the high yield market reached their highest levels since late 2011.

Developed Market Equities

Developed market equities began 2016 in decline, returning -6% in January as China-driven concerns and low oil prices created global risk-off sentiment. In the U.S., equities returned -5% as a weak auto report and headlines warning of a looming earnings recession renewed concerns over the state of the U.S. economy. European stocks fell -6.2% in sympathy with global equities even as Mario Draghi reassured the market of his confidence in the ECB reaching its inflation target. Japanese equities fell 8% in January amid generally weak economic data, which in turn sparked a cut in the benchmark rate by the BOJ near the end of the month.

Emerging Market Equities

Emerging market equities fell in line with developed markets, returning -6.5% as the outlook for global growth remained negative amid persistent China weakness and low commodity prices. In China, GDP growth hit a 25-year low and Chinese equities declined -22.7% over the month. Further yuan devaluation and suspension of equity trading nationwide not only failed to stem the decline, but increased policy uncertainty. China’s weakness continued to fuel concerns over Brazil’s export-driven economy, and Brazilian equities also began the year in negative territory, returning -6.8%.

Mortgage-Backed Securities

Agency mortgage-backed securities (MBS) underperformed like-duration Treasury by 39bps amid lower rates and broad risk-off sentiment. During the month, Ginnie Mae MBS underperformed conventional MBS due to supply pressure, convexity concerns and limited interest from overseas investors, 15-year securities marginally outperformed 30-year securities, while securities with lower coupons modestly underperformed those with coupons of 4.0% and 4.5%. prepayments increased by 14%, the Fed continued to reinvest the pay-downs from its MBS holdings, purchasing approximately 25% of gross issuance in January. Non-agency MBS prices declined and spreads widended amid the broad market volatility. However, market technical continue to be favorable, underlying collateral performance has been stable and housing fundamentals remain insulated from global macroeconomic concerns.

Emerging Market Debt

Emerging market debt returns were mixed as the triad of negative developments – weak oil prices, uncertainty in China and shifting expectations about the path of the Fed’s policy normalization – drove volatility higher. Although emerging local yields, currencies and external spreads over U.S. Treasuries began the month under considerable pressure, local returns were positive, though currencies still slipped, and external debt returns ended the month down only slightly. Across external debt, Brazil notably outperformed as political headlines remained muted. Oil importers like South Africa and Turkey also outperformed, while returns from exporters lagged. Expectations that the Fed would further delay U.S. rate hikes pushed yields lower in Indonesia, Brazil and Hungary, but oil exporters like Colombia and Russia trailed. Malaysia posted the strongest local currency returns as the prime minister was cleared of wrongdoing in a corruption probe.

Commodities

Gains in some commodity sectors were not enough to offset losses elsewhere, leaving commodity index returns in negative territory in January. Crude oil fell below $30/barrel for the first time in over a decade, in large part due to volatility in Chinese markets and the expectation for additional supplies out of Iran. The back end of the crude oil curve saw further pressure from financial flows, as banks looked to hedge price exposure from their credit lines to energy companies. Precious metals were the best performers for the month, with gold rallying over 5% on safe-haven demand. In agriculture, gains in grains (wheat, corn, and soybeans) were offset by losses in soft commodities (sugar, coffee and cotton).

Currency

The U.S. dollar broadly strengthened in a risk-off month, as market anxiety over the potential for slower global growth and falling commodity prices prevailed. Currencies of commodity exporters across both developed and emerging markets (Australia, New Zealand, Russia, Colombia, Mexico, South Africa) slid more than most. The U.S. dollar modestly gained against both the Japanese yen and euro, with the BOJ introducing negative policy rates and the ECB reiterating its accommodative stance. In Europe, the pound sterling trailed on policy rate path uncertainty and the Polish zloty fell after S&P surprised markets by downgrading the country on institutional concerns. Finally, in Asia, a weak yuan fixing at the start of the month drove China’s currency lower while the Indian rupee weakened on capital outflows. The Malaysian ringgit proved to be a diamond in the rough when Prime Minister Najib Razak was cleared of wrongdoing related to the state fund known as 1MDB.

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