Currency and Credit Markets Take Trade Tensions Mostly in Stride

(Bloomberg) -- Global equity markets freaked out as the Trump administration ratcheted up protectionist rhetoric this week. Currencies and credit had more nuanced reactions.

Treasuries had a measured response to the tariff talk between the U.S. and China, while corporate credit mirrored the roiling equity picture. In foreign exchange, emerging-market currencies have actually gained of late. Some developed-market currencies enjoyed a brief boost as investors looked for a sanctuary, but volatility held steady.

Here’s a rundown of the markets as a tumultuous week comes to a close.

Treasury Rally

Treasuries rallied Thursday, with the benchmark 10-year yield falling about six basis points, the second-largest decline of the year.

Yet unlike the 14-basis-point drop in early February, which coincided with the equity-market rout, volatility remained subdued in the world’s largest bond market. The Bank of America Merrill Lynch MOVE index barely budged from near its lowest level since January, while last month it soared to a 10-month high.

In another sign of relative calm among bond traders, key market levels held firm. The 10-year yield bounced off the 2.8 percent level yet again, as it has for more than a month, limiting the flight-to-quality gains. It briefly dipped below the 50-day moving average, before rebounding to 2.84 percent Friday morning.

“When the risk appetite pendulum swings toward ‘off,’ Treasuries are going to rally only so far in the short term,” Jim Vogel, a strategist at FTN Financial Capital Markets, wrote Friday in a note. “Bond flows are elevated, not frantic.”

Corporates Wobble

Spreads are wider across many parts of the credit market as debt assets mirror the stock-market retreat. The Markit iTraxx Europe index of CDS on investment-grade issuers added as much as 2 basis points, having crossed above 60 basis points Thursday for the first time since June. The Bloomberg Barclays IG OAS index of highly rated U.S. corporate debt slipped to the widest level since September, expanding to 109 basis points from 106.

Some of the biggest moves have been in subordinated financial bond spreads, with Deutsche Bank contingent convertibles among the worst performers. Other riskier debt has also traded off, with European leveraged-loan prices dropping around 25 basis points, extending losses for the week.

Outflows from high-yield funds are beginning to weigh on spreads and new issuance. Speculative-grade European funds have endured 18 straight weeks of investor redemptions, according to a Bank of America Merrill Lynch client note citing EPFR data for the week ended March 14. The most recent data from Lipper shows U.S. corporate high-yield funds returned to outflows.

EM Currencies Gain

Emerging-market currencies have gained 0.2 percent this month against the U.S. dollar, led by the Mexican peso, Hungarian forint and Czech koruna.

“EM currencies have been remarkably well-behaved since all of this kicked off,” said Edwin Gutierrez, London-based head of emerging-market sovereign debt at Aberdeen Standard Investments.

The “losers” are China’s supply chain, he said, although it’s not that simple: “One way to fly below the radar in the eyes of Tough-Trade-Talkin’ Trump is to let your currency appreciate versus the dollar.”

Further escalations in trade tensions will be most damaging to Asia’s small open economies, where supply chains would be hurt by actions targeting China, Goldman Sachs Group Inc. analyst Ian Tomb wrote in a note.

FX Havens

News that China would hit back with tariffs on roughly $3 billion of American goods initially sparked a rally in classic haven currencies such as the Japanese yen and Swiss franc. The yen pushed past 105 against the dollar, a level unseen since November 2016, while the franc gained as much as 0.5 percent against the greenback.

But global currency volatility barely budged, and those early flight-to-quality bids faded as cooler heads prevailed. The scale of both the China and U.S. tariffs isn’t yet large enough to affect the global economy, according to Jefferies Group LLC global foreign exchange head Brad Bechtel.

“It’s not going to derail the Fed, it’s not going to derail anything,” Bechtel said. “Currency traders are just having more of a level head about it while equities are manifesting the panic.”

Commodity-sensitive currencies such as the Canadian dollar, New Zealand dollar and Australian dollar were Friday’s biggest G-10 gainers against the greenback. The rally in Australia’s currency suggests that traders don’t yet see a big risk to China’s economy, Bechtel said.

©2018 Bloomberg L.P.

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