IMF Turns the Volume Down on Investor Optimism and Warns that Recession Is Not over Yet

So, what the IMF essentially said was: stay healthy, stay safe, don’t do anything foolish as an investor because we’re not nearly out of the woods yet. That didn’t scare investors from a 100-year bond issued by the Republic of Austria – as a matter of fact, as global equities went down, RAGB 0.85 06/30/2120 went through the roof price-wise. Obviously because it’s a safe haven investment. How are CROATIs doing in an environment like this? Read it in this brief research piece.

You might have a feeling that at least the leading economic indicators around the globe are gradually improving. Remember the jaw-dropping jobs report in the United States just two weeks ago? US economy added 2.5 million jobs in May, the biggest one month snap since 1948. Did you know that US unemployment hit 14.7% in April, the highest jobless figure since the end of World War II? Well, a month later it was already down to 13.3%. PMIs around the world are painting a picture of a V-shaped recovery, although PMIs track only expectations and it might take time before they translate into hard economic data. Finally, yesterday’s IFO came slightly better than consensus estimate, two out of three indices were above the forecast: Business Climate (86.2 versus consensus of 85.0) and Expectations (91.4 versus 87.0), while Current Assessment was lagging the survey (81.3 versus survey of 84.0).

A cold shower came from the IMF who sees the glass half empty and warns us not to make too much out of a handful of good data. In it’s World Economic Outlook the Washington-based lender of last resort downgraded global growth 2020 forecast from -1.9% YoY to -4.9% YoY, citing the implicit cost of social distancing and pure, simple fear (this is what an increase in precautionary household savings actually means) as main two reasons for this downgrade. Revised figures look a bit terrifying, but several analytics were already suggesting that such a deep 2020 contraction might be possible: US -8.0% YoY (-1.9% YoY in April), Germany -7.8% YoY (-0.8% YoY in April), France –12.5% YoY (-5.3% YoY in April), Italy -12.8% YoY (–3.7% YoY)…. No forecast was submitted for countries such as Slovenia, Croatia, or Serbia, but if you remember that their economies are highly correlated with Italy, then you do now what to expect when these figures show up in a couple of weeks. Although the announced fiscal measure around the globe already reached 11 trillion USD, the IMF also downgraded it’s forecast of a recovery in 2021 due to the possibility of another pandemic early next year. Speaking about 2021 recovery, the review was bifurcating in a sense that for some countries such as Germany, Italy and France the growth rate was upgraded, but significant reductions were made in emerging Asia. India in particular is becoming a problem, since both 2020 and 2021 growth figures were revised downwards (from +1.9% YoY in April to the current value of -4.5% YoY for 2020, from +7.4% YoY to +6.4% YoY for 2021). One last thing before we turn to another topic: have you noticed that the IMF somehow ignores the evolving social unrest in United States and rising trade tensions coupled with Trump’s harder stance on immigration? In a risky political gamble ahead of November’s presidential election, Trump issued an executive order putting hard restrictions on issuance of new green cards and temporary-work visas, including the H-1B visa – the primary source of talent attracted to US that was fuelling it’s booming tech sector.

Regarding financial markets, an upbeat and supportive environment was once again emphasised yesterday when Austria placed 2bn EUR of centenary bond (2120 maturity), it’s second in three years. First thing you could have noticed once the IPTs were delivered to your mailbox was that the indication was displayed in YTM terms (IPT @ 0.95%), instead of an I-spread. Isn’t it obvious why? Who can price a 100-year interest rate swap? IPTs were initially some 7-8bps above the existing RAGB 100Y, which was huge once you remember that centenary bonds have a modified duration of about 65-70. Naturally, the yield tightened to about 0.88%, at the same time German yield curve moved down, meaning there was still some room left for spread tightening. The book was ordinarily oversubscribed by a degree of 8.85x (17.7bn EUR of orders), but it’s a normal thing for an SSA like Austria to be oversubscribed to a degree 6.0x-10.0x. Grey market trading was like a roller-coaster because of the high duration – it was like trading Turkish or Russian eurobonds, which normally make 100 pips of a move in a couple of minutes. Once the dust over IMF’s review has settled, old centenary bonds were traded around 0.74% YTM, while the new ones were around 0.78%. Yes, exactly – that means they were traded 700 pips above the reoffer (grey bid @ 105.00, reoffer @ 98.01). And don’t worry, even if you had the guts to get in on the primary, you wouldn’t have held it long enough to cash in all of the 700 pips it made.

Regarding Croatian eurobonds, we saw 5mm+ USD CROATI 6 01/26/24 being offered at 115.00 (1.66%, T+135bps), which doesn’t look bad at all once you account for 0.35% hedging costs and remember that in three short weeks Croatian banks might go through a CROATI$ buying frenzy since 100mm USD of CROATI 6.675 07/14/2020 they already have on their books will mature. Looking at the EUR yield curve, a demand for CROATI 1.125 06/19/2029 is still not abating and a couple of days earlier you could have switched as much of 29s you wanted into 27s at an equal Z-spread. Once again, we see CROATI 3 03/20/2027 as better offered, but we think the local demand will scoop that up in no time. Finally, the new paper, CROATI 1.5 06/17/2031 – if you take a look at the MOSB function on BBG, you could see it being traded yesterday in 99.05-99.375 range. Here’s an interesting piece of data – a bigger chunk (about 7.8mm EUR) was traded at 99.20. This might be an indication that some Street banks might be running out of excess inventory, because it’s only them who can offer sizes like this. It’s too early to tell, but at this point it looks as if big sell orders are quietly disappearing from the market, allowing the bond price to make another quantum leap to 100.00+ levels in the near future. July is generally a coupon month, meaning that there might be excess cash hunting for products like 11Y CROATI. Plus, don’t forget that 1.25mm USD of CROATI 2020 will mature in a matter of weeks, some of it being held by non-bank domestic accounts (short term UCITS funds liked this instrument very much). If the environment remains supportive, CROATI upside might become apparent in the weeks ahead.   

Ivan Dražetić
Published
Category : Blog

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