I quite like keeping a close eye on fund flows as an indicator of sentiment and the big story of 2019 so far has been a simple one. Equity prices might have rebounded (and subsequently stumbled) but investors are voting with their feet – selling down equity funds and reinvesting the proceeds into bond funds. The most recent evidence of this comes via data from the European Fund and Asset Management Association (EFAMA) which has just published its European wide survey for numbers through to the end of the first quarter of this year. This looks at 29 different investment associations, representing 98 percent of total UCITS and AIF assets. The stand out number – the Net sales of bond funds increased to EUR 43 billion, from EUR 14 billion in February whilst UCITS money market funds recorded net outflows of EUR 2 billion, compared to net inflows of EUR 4 billion in February.
The obvious message here is that investors are turning to bonds, preferably government securities. This can be seen very clearly in the next bunch of charts, with the first one for a key UK gilt issue. This first chart is from www.sharepad.co.uk and shows the price of the UK gilt ticker TG28 – a relatively recently issued security paying 1 and 5/8th coupon through to October 2028. The yield to maturity on this popular security is now a tad under 0.80% per annum, for just under nine years.
Looking more broadly at an adjusted basket of ten-year gilts, the overall yield to maturity is now running at 0.88%. The chart below shows this yield over the last ten years. My guess is that we’ll see most longer-dated gilts trade at well under 1% for the next few weeks, with a possible push below 0.7 if we get more bad news.
The next chart suggests more bad news – it shows the spread between US Treasury 3 month securities and 10-year securities. The current spread according to this Bloomberg grab is close to levels last seen in 2007.
The cause of all this angst is obvious – trade wars. If President Trump wants to avoid a recession before elections next year, I’d cordially suggest he’s going the wrong about it. Markets are clearly signaling recession risks. My guess is that tensions will escalate first before some kind of deal is done but markets aren’t in a patient mood. Which brings me to my last chart. It’s from the macroeconomics team at Barclays and shows what they think is the consensus expectation for Fed rates in the remainder of this year. According to Barclays, they “expect the Fed to cut its policy rate by 75bp this year beginning in September. Earlier action is not out of the question if financial conditions deteriorate rapidly”. So much for the great Interest Hike narrative, battling with surging inflation and a return to ‘normal’ long term interest rates. The markets clearly believe that we are stuck in the Low(er) Rates for Longer Model.
Which brings me nicely to one last titbit, relating to the CLO market. This little tale clearly shows how once we dig beneath the big macro trends we discover lots of interesting sub narratives, which don’t always back the main narrative.
This concerns Japanese buyers of highly rated CLO paper and the story comes from a specialist manager in this space, Fair Oaks. They’ve long been worrying about “the potential risk to the primary CLO market from a concentrated AAA investor base as a small number of Japanese banks are a key source of financing for the CLO market. Market sources estimate that Japanese banks have purchased over 30% of primary CLO AAAs over the last few years. In Europe, it is estimated that Japanese buyers accounted for two thirds of primary CLO AAAs in the first quarter of 2019”. CLO AAAs have underperformed in 2019. While investment grade corporate spreads have tightened significantly (19 and 23 bps in Europe and the US respectively), CLO AAA spreads have widened slightly. Maybe the CLO market is telling us that those investors with the longest experience of a Low Rates environment aren’t quote so worried.