Aurelia Butler

BENGALURU (Reuters) – U.S. Treasury yields a year from now are forecast to trade sharply lower than the level expected by bond strategists polled by Reuters just one month ago, underscoring how much financial markets have diverged this year from the central bank’s view.While the U.S. economy grew at an annualised 2.9% in the final quarter of last year, it is clearly losing momentum. Market traders and policymakers differ on the severity of the coming downturn, as well as the likely policy response.Bond strategists at JPMorgan (NYSE:JPM) noted recently that the U.S. Treasury market is already priced for a recession and not just for the heightened risks of one.”In the latest rally, Treasuries have diverged further from their underlying drivers…10-year yields appear 30 basis points too low after controlling for the market’s Fed policy, and growth expectations,” they wrote in a recent note. Already off their peaks from late last year and early 2023, major benchmark government bond yields have eased 20-40 basis points since, and more than 50 basis points on the particularly rate-sensitive U.S. two-year Treasury yield. Economists – many from the same banks – broadly expect the Federal Reserve to raise interest rates a few more times before pausing, with no reductions due this year, suggesting that the fall in two-year yields is too early. They also say the risk to their outlook is that rates stay higher for longer, rather than the other way around.Benchmark 10-year U.S. Treasury yields were forecast to rise from 3.50% on Thursday to 3.70% in three months and then drop to 3.60% and 3.25% in six, and 12 months, respectively, in the Jan. 18-27 Reuters poll of 58 strategists.That is about 30 basis points lower on the one-year horizon than a poll published in December.U.S. two-year yields were also expected to drop from around 4.15% presently to 3.52% in a year, more than 40 basis points below the 3.94% forecast from last month’s survey. This would extend one of the longest periods on record where two-year yields have been higher than 10-year ones, a yield curve inversion. Every U.S. recession since 1955 has been preceded by an inverted yield curve.But the Fed has indicated it is not ready to even consider cutting interest rates any time soon. “While markets are currently penciling in the first cut in late 2023, we expect the first cut only in Q1 2024 and look for the curve to stay inverted for longer, as front-end rates remain elevated and the long end continues to price in slowing growth momentum,” said Priya Misra, head of global rates strategy at TD Securities.Sovereign bond yields in the euro zone and Britain, where policymakers also are not done raising rates and are grappling with even higher inflation than in the United States, were predicted to trade lower in a year, too.The poll expected German bund yields to rise from their current 2.25% to around 2.4% in three and six months. They were then forecast to fall back to 2.05% in a year.Gilt yields, last trading around 3.30%, were forecast to rise and peak at 3.45% by end-March and remain near these levels for another three months and then fall to 3.20% by year end. More

Now, the Detroit rivals must convince investors that last year’s profit formula can keep working when costs for EV batteries are rising, high interest rates are cutting consumer purchasing power, and Tesla (NASDAQ:TSLA) Inc is slashing prices. Already there are signs the Detroit automakers are scaling back spending to offset competitive and economic pressure. GM has shelved for now plans to build a fourth EV battery plant in North America. Ford is in talks with German unions to cut thousands of jobs in its European operations and possibly sell a German vehicle assembly plant. In October, it stopped funding autonomous vehicle affiliate Argo AI.GM and Ford both rely on sales of pickup trucks and SUVs in the United States for the bulk of their global profits. This year, both automakers plan to ramp up sales of much less profitable electric vehicles in North America and other markets.The risk to the Detroit automakers’ profitability would be a challenge in the best of times. But now, GM and Ford must factor in forecasts for a slowdown, or even a recession, in the U.S. economy. EV battery raw material costs are rising, but U.S. EV market leader Tesla is cutting prices on its best-selling Model 3 and Model Y vehicles by as much as 20%. The Model Y SUV competes with Ford’s Mustang Mach-E, GM’s Cadillac Lyriq EV, and with combustion SUVs the Detroit automakers sell. Morgan Stanley (NYSE:MS) estimated increased prices added an average of $3 billion a year to Ford’s pre-tax bottom line and was the equivalent of more than 200% of the improvement in the company’s pre-tax profits for 2022.GM, the No. 1 U.S. automaker by sales in 2022, said higher prices added $2.1 billion to pre-tax profits in the third quarter compared to the same quarter in 2021 – equivalent to nearly half of pre-tax profits for the period overall.The company has told investors it will spend $35 billion on electric and automated vehicles between 2020 and 2025. Ford has put its planned EV investments at $50 billion through 2026. “If we are entering a downturn,” Morgan Stanley analyst Adam Jonas said, “what steps can they take to keep investing and remain strong?” More

Jay Newman was a senior portfolio manager at Elliott Management and is author of the finance thriller Undermoney. Benjamin Heller is a portfolio manager at HBK Capital Management, specialising in emerging markets.The world of distressed sovereign debt seems to attract bad ideas like no other, mostly generated by G-20 bureaucrats and the International Monetary Fund. The most recent is the Common Framework for Debt Treatment, which is neither common nor a framework, but, rather, a recapitulation of the ad hoc nature of the process for resolving sovereign defaults. Twenty years ago it was the Sovereign Debt Restructuring Mechanism, a Trojan horse to establish a sovereign bankruptcy court presided over by the IMF, itself a creditor and expert witness. And let’s not forget the Highly Indebted Poor Countries initiative, a program that relieves badly managed, corrupt countries of their obligations without generating growth, strong domestic institutions, or even enduringly clean balance sheets. We also have the IMF and the G-7 to thank for the creeping loosening of collective action clauses, slyly converting them from a tool to facilitate orderly restructuring into a poison pill that renders sovereign debt functionally unenforceable.But the granddaddy of bad ideas is the so-called Brady Plan, a gimmick that — had it not been designed and blessed by the US government — would have landed a lot of people in jail for accounting fraud.Simply put, the Brady Plan packaged up defaulted and distressed junk sovereign debt with long-dated zero-coupon US Treasury bonds. The express purpose — the sole purpose — was to enable otherwise insolvent Western banks to avoid recognising huge losses on their portfolios of developing-country debt. Brady bonds never made any economic sense. But those were the days: when bank regulators did their patriotic duty, turned a blind eye to the deep holes in bank balance sheets and did . . . nothing. Ironically, once the new bonds left bank balance sheets, bondholders and issuers spent much of the late 1990s and early 2000s unwinding collateralised Bradies — and sharing the not inconsiderable gains available from disassembling a structure that both sides found economically inefficient. Now, two experts in complex financial and legal structures, Lee Buchheit and Adam Lerrick, are proposing to recycle the Brady Plan. The FT’s Martin Wolf wrote in January about how the plan offers a potential escape route for “low and lower-middle income countries” that “have taken on too much of the wrong kind of debt.” That’s a fair point. But whether, as he concludes, that “reflects mainly on the lack of good alternatives” is open for debate.There’s plenty of room for scepticism about the mechanics of implementing the template, as FT Alphaville has already pointed out. Not least is that it proposes the creation of the kind of structural complexities that only a quantitatively-minded hedge fund trader could love.To wit: “this proposal will convert the entire debt stock . . . into 25-40 year debt,” which “should reduce the net present value of the debt by more than 50 per cent and place the debt on a sustainable path.” That reduction would be accomplished by offering bondholders a “cash downpayment” funded by new zero-coupon loans from the World Bank and the IMF. Of course, the World Bank “can use derivatives to transform the . . . zero-coupon into a standard . . . floating-rate liability.” Then there’s a so-called Floor of Support Structure that will enable the debtor to magically discharge those new debts at maturity. Hmmm.The template may be impenetrable but at least (like the Brady Plan) its heart is in the right place. Unfortunately, good intentions are not matched by clear purpose. As far as results, there will be a lot of new instruments for well-paid hedge funders and bankers to slice and dice and a lot of new money coursing through the system. How the plan will solve any real problems, though, is a mystery.So many of these “big” ideas are generated by, or on the backs of, the international institutions. Inevitably, they are solutions in search of problems that would be better addressed directly. It’s a cunning bit of intellectual prestidigitation to conflate insolvency with “a debt problem” — as though the debt load landed on the country unbidden like an alien spacecraft. Is the problem just the debt? Or is it the total failure to mobilise fiscal resources? Or poor management of those resources? Failure to create a fertile environment for growth? It is odd to think that — to take a random example of a country where talk is bubbling up about a possible debt restructuring — Nigeria needs a debt write-off, but nothing needs to be done about the fact that the country mobilises 6 per cent of GDP in tax revenue.Another current event is the case of Sri Lanka: the IMF, as ever, is intent upon imposing its own opinion of debt sustainability. It’s past time for creditors to come up with their own benchmarks for sustainability, much in the way bank advisory committees did in the 1980s. Unlike the IMF, private creditors would propose actual standards for fiscal effort and reject sandbagged growth trajectories based on the soft bigotry of low expectations.What never comes up in the myriad conferences on sovereign debt, or in the research and discussions led by the official sector, are the root causes of sovereign debt defaults: corruption, weak governance and domestic institutions, refusal to forego borrowings in foreign currencies, and the failure to prevent defalcation, much less to recover ill-gotten gains.At some level, Buchheit and Lerrick understand that serial defaulters have problems that go beyond the mere existence of debt. The one sensible piece of their proposal calls for structural restraints on borrowers’ ability to re-lever themselves with new borrowing after going through their neo-Brady Rube Goldberg machine. They know better than to put a non-recovering alcoholic next to an unlocked liquor cabinet.Yet, for the official sector, feckless fiscal performance, political mismanagement, and the concomitant sovereign debt problems are more an opportunity than a problem. Problems, after all, are their raison d’être.Countries are most often poor because they are badly governed by a political class intent on collecting rents, not providing honest services. Fancy templates, frameworks, initiatives, and plans ignore root causes of the human misery that results from this misbehaviour. They are misdirection, solve nothing, obscure the underlying problems, and absorb attention that might otherwise be productively directed at solving them. More

The writer is co-head of investment and group chief investment officer at SchrodersThe market misery of 2022 was almost universal, inflicted by a seismic regime shift towards both higher inflation and higher interest rates.Investors faced by tumbling equities couldn’t find the sanctuary in bonds they have grown accustomed to. As the S&P 500 index fell 19 per cent over the year in dollar terms, 10-year Treasuries dropped in virtual lockstep, losing 19 per cent.This made things very difficult for the popular 60/40 portfolio of bond and equities which usually aims to deliver “inflation-plus” levels of returns. A portfolio of 60 per cent US equities and 40 per cent long-term US government bonds would have underperformed inflation by 28 per cent in 2022.The “Fomo” market of earlier this decade, where investors crowded into a small number of evermore expensive growth stocks owing to the fear of missing out, was soundly quashed. The handful of tech behemoths that had previously added so much to index returns were the very ones which dragged the US market down last year. A portfolio of the seven largest US companies in the MSCI USA index from a year ago would have lost investors 40 per cent in 2022. A portfolio of the rest would have lost only 14 per cent.It wasn’t just investors in traditional assets that felt the pain; cryptocurrencies collapsed. Bitcoin fell 65 per cent over the year, while “stable” coins Luna and Terra proved anything but as they plummeted amid a whirl of scandals and failures, most notably at the crypto exchange FTX.So where does this leave investors in 2023? After a decade of zero rates and quantitative easing, investors need to adapt to an environment where structurally higher inflation will require central banks to run a more active monetary policy. For 2023, we expect inflation to be falling and, with the risk of recession, bonds will be a helpful diversifier once more. But given medium-term pressures on inflation, the case for owning bonds now rests more on the yield they offer. This is a change from the past decade when bonds offered little or no yield and diversification was their main appeal, rather than the income they provided.We expect an increased divergence in interest rate cycles across countries and regions. Nations less reliant on external funding and that have showed policy discipline may be rewarded, while others may be punished. There are now more opportunities to invest in different bond markets based on one’s expectations of where rates in those countries are heading.Similarly, companies that have survived as a result of low borrowing costs may soon find themselves struggling against a backdrop of higher rates. It will be essential to assess which companies are able to pass on higher costs to their consumers: those that can’t will see margins come under pressure.Price-to-earnings valuation ratios are likely to be lower and investors will be more focused than ever on the earnings part of that coupling. Elsewhere, with a tense geopolitical environment, commodities are a helpful source of diversification, having fallen by the wayside in the loose money period of quantitative easing.After a prolonged strong period, underlying US profit margins are at record levels. As we’ve seen with the tech sector, cost pressures in the US are now making themselves apparent at a time when revenue growth is clearly starting to slow. Negative operating leverage — where fixed costs comprise a greater portion of a company’s total cost structure while sales simultaneously decrease — is beginning to kick in. Yet Wall Street still expects 4 to 5 per cent earnings growth for the S&P 500 in 2023, which seems optimistic. The rest of the world definitely looks more interesting, especially Asia.China’s economy was far more resilient during the “exit wave” from Covid than had been expected. And with high frequency indicators suggesting that activity has already begun to pick up sharply as the number of Covid infections has subsided, the near-term outlook for the economy is goodThe new market regime is about more than just inflation and interest rates. Structural changes to supply chains, shifts in energy policy and a surge of investment in technology like semiconductors will create opportunities among a new wave of companies. Some of the investment themes that have emerged in the past few years will only strengthen — and new ones will emerge.Last year was significant in ushering in these fundamental changes. 2023 is also likely to be turbulent as these shifts becomes more established in investor psyches. More

The IMF’s former chief economist Olivier Blanchard needed just three words to respond to the news that Brazil and Argentina would begin preparatory work on creating a common currency. “This is insane,” he tweeted.While economists have questioned the viability of the idea, political analysts have been less dismissive, pointing out that the desires of South America’s mainly leftwing presidents to promote regional integration and challenge the US dollar’s dominance should not be underestimated. For the first time in more than seven years, Brazil and Argentina are politically aligned under leftist leaders, with both Luiz Inácio Lula da Silva and Alberto Fernández keen to present a united front. Brazil’s president told reporters in Buenos Aires earlier this week that, “God willing”, the finance ministers and leaders of the two central banks would have the “intelligence, competence and good sense” to begin work that could eventually produce a common currency.His Argentine counterpart said while he did not know “how a common currency with Brazil and the region would work,” the two nations would have a “much deeper strategic bond” that would last “for decades.”The two leaders made clear that an eventual common currency would, at first, be limited to use in trade and would run in tandem with Brazil’s real and the Argentine peso, rather than replacing them.

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This is not the first time that the idea has been floated. People close to the previous rightwing administration in Brazil confirmed that former finance minister Paulo Guedes had defended the idea several times on the grounds that the currency would help impose fiscal discipline and that there would be fewer global currencies in the future so it would be beneficial if the region established its own. Guedes even suggested a name, the “peso real”, and predicted a 15-year timeline for such a project in Latin America. Argentina’s former central bank chief Federico Sturzenegger, who served from 2015-2018 under the conservative administration of Mauricio Macri, was supportive of establishing a central bank among members of the Mercosur trade bloc. Latin America’s left has long wanted to reduce the region’s historic dependence on the United States and sees a common currency as a clever way to claim greater economic sovereignty while also pursuing a long-held dream of closer political union. In a nod to those tensions with its rival north of the equator, Brazil’s current finance minister Fernando Haddad last year co-authored a piece suggesting a common currency called the “sur”, or south. Underpinning the political support is a desire to stabilise Argentina’s battered economy. The country has been on the brink of insolvency for years, its central bank reserves are dwindling, tight exchange controls have fed a rampant black market in the dollar and confidence in the peso has collapsed. “Argentina needs an external anchor to restore credibility,” economist Rodrigo Wagner, an expert on new currency adoption, said. The financial chaos has weighed on trade between the two economies. At roughly $30bn in 2022, flows between Brazil and Argentina are lower than the $40bn level recorded a decade ago. That is partly because Argentina has a chronic shortage of US dollars — the common currency of global export markets — to purchase Brazilian exports. “Trade is certainly facilitated by a common currency and eliminating FX risks brings advantages,” said Nannette Hechler-Fayd’herbe, global head of economics and research at Credit Suisse. However, she highlighted that monetary unions also posed challenges to member states, as the history of the EU’s single currency project showed. Pierpaolo Barbieri, founder of the Argentine fintech Ualá, said it was too easy to be cynical about the plans. “Brazil wants a larger market for its exports and to lower trade barriers,” he added. A common unit of exchange would be an “ultimate vehicle” towards achieving both.

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Digital currencies, such as Tether and Bitcoin, were already offering alternatives. “Anything that opens up our extremely closed market is a step in the right direction,” said Barbieri. Everton Guimarães Negresiolo, president of the Argentine-Brazilian Chamber of Commerce, Industry and Services, has said “a bilateral trade tool” in a currency “other than the dollar” would be beneficial to the businesses they represent — though he acknowledged that a string of economic imbalances between the two countries posed “very important challenges”. “It is very positive news to learn that we are working towards greater regional integration,” said Gustavo Grobocopatel, who heads one of Argentina’s largest farming groups, Los Grobo, adding that the announcement was one way to get member states to “start doing the homework” on the imbalances.

Wagner said the lack of an alternative to dollars meant South American nations, including his native Chile, were missing out on valuable trading relationships. But others argue the scale of the disparity between the two countries makes the project a non-starter. Buenos Aires has been cut off from international debt markets since a default in 2020 and has tight foreign exchange controls. The real, meanwhile, is fully convertible, and a better grip on government spending means the country has full access to international markets. Annual inflation in Argentina reached 94.8 per cent in December, against a far more manageable 5.79 per cent in Brazil. Marcos Casarin, chief economist at Oxford Economics, said: “Argentina has more inflation in a single month than Brazil [has] in a year.” “My perception is this common currency is not going to be feasible. And if it is feasible, it is going to create increasing turbulence in our economy,” said Walter Schalka, president of São Paulo-based Suzano, one of the world’s biggest pulp and paper companies. “Argentina and Brazil are facing different economic moments. They’re in a completely different situation. This is something that is not going to create any value for Brazil.”Additional reporting by Jonathan Wheatley More