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Market weekly – Fixed income: 2021 reflation trade, where art thou? (read or listen)

In mid-June, Fed Chair Jay Powell pulled the rug from beneath the reflation trade by suggesting current inflation pressures were perhaps not transitory after all. Fixed income markets promptly reversed course with 10-year US Treasury yields last week…

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In mid-June, Fed Chair Jay Powell pulled the rug from beneath the reflation trade by suggesting current inflation pressures were perhaps not transitory after all. Fixed income markets promptly reversed course with 10-year US Treasury yields last week trading as low as 1.25% after ending the first quarter at 1.70%. In this week’s podcast, Olivier de Larouziere, chief investment officer fixed income, explains what remains of the 2021 reflation trade.

Listen to the podcast with Olivier de Larouziere, chief investment officer fixed income, or read the article below.

Regime change in June? Or just a pause?

We recently saw the consensus view held by the market on US interest rates bowled over by the Federal Reserve. Whereas the market expected no or at the most one interest rate rise over the next two years, the Fed’s ‘dot plot’ indicated that policy rates could rise by as much as 50bp by 2023.  

Prior to the Fed’s policy meeting in June, bond markets were clearly positioned for higher rates. The expectation in the market was that inflation would rise and the Fed was pursuing a new policy of driving inflation higher to reflate the US economy.

As a result, market participants were, in our view, overwhelmingly underweight interest-rate risk (duration) versus their benchmarks, in other words, the expectation was that bond prices would fall. Chair Powell’s comments triggered a repositioning on the basis that the Fed was, after all, not prepared to tolerate higher inflation and was ready to raise policy rates in response. 

It is worth noting that all this affected positioning in not only US Treasury bonds, but also German Bunds. Here too, market volatility increased as participants reacted to the unexpected news.

While the Fed has appeared to let go of its – until recently – sanguine view on inflation and has shifted to an assessment that action is needed to contain price pressures in the economy, the apparent rationale behind June’s policy rate signal is clouded by a few provisos.

  1. The Fed’s ‘dot plot’ policy outlook indicated inflation would peak this year and be more muted in 2022 and 2023. That could have been a reason to hold off on a tightening signal.
  2. While macroeconomic data has been pointing to a strong recovery in the US from the pandemic-related shutdowns, there have been signs more recently that the peak in GDP growth is in fact in sight. It may even be behind us. Indeed, the recovery of the Chinese economy, which was first in and first out of the pandemic, has already plateaued. This too could have motivated the Fed to stick to the view that recovery-related inflation would dissipate.
  3. Finally, negotiations in Congress on the latest stimulus package – a set of large-scale infrastructure measures – are moving in the direction of a compromise reducing its overall size. That should limit its effect on the economy. More generally, there is a view that fiscal tightening is coming – an end will have to come to all the ‘doing whatever it takes’ – both in the US and Europe.
  4. Recent experience with the Delta variant of Covid-19 suggests there will be no rapid exit from the global pandemic, which may delay reopenings with negative economic consequences. There is also a marginal risk of new variants.

The Fed’s changed view – or was it just the tone – caused a highly unexpected, so-called bullish flattening of the US yield curve in which shorter-term yields rose to reflect the expected policy tightening in two years’ time, but 10-year rates held steady or eased.

Many investors had held positions anticipating a steepening, not flattening, of the US yield curve on the basis that higher inflation would drive interest rates higher. Now, however, there appear to be grounds for a very different narrative.  

Our view today is that many participants have not yet adjusted to the change in narrative. There may well be further to go before we can think about a revival of the reflation trade. However, time is crucial in fixed income, who knows how events will change in the meantime? The reflation trade may well dust itself down and continue, but now it is very much on the ropes.

What happens next?

It is unclear what the Fed’s approach to monetary policy is now. Under its new framework, it had appeared that the central bank was focusing on average inflation and dealing with price pressures over a period of time. This had been seen to mean that a period of above-target inflation would follow a spell of below-target inflation to arrive at the average.

Now, however, there appears to be a view that more immediate action is needed, hence the expectation of two rate increases totalling 50bp by 2023. This shift back to the previous policy regime has dented central bank credibility and left markets with a greater need for clarity. This matters not just for Fed watchers, but also for those following the ECB, which has signalled it would react if there were large diversions from its newly firmed-up 2% inflation target.

Are there any implications for plans by the Fed to taper its trillion-dollar support for the US economy? The central bank has started discussions on reducing its (stocks of) asset purchases in light of the progress the economy has made on restoring employment and inflation, but appears to be leaving aside risks to growth such as fiscal tightening, in other words, any tax increases the Biden administration is considering to help pay for the stimulus packages.

For investors, we think markets now understand that the tapering of monetary support – unwinding the asset purchases that were to hold down rates as the economy sought to recover from the pandemic-induced – is a process whose effects last longer than previously thought. It is also important to differentiate between the stocks of assets held by central banks, which will remain stable, even when the flows change as central banks taper.

As a result, there is an inclination to hold on to overweight positions in sovereign debt by investors keen to benefit from the carry such assets provide, even as tapering gets underway. This may initially limit any move higher in interest rates.

The impact of tapering is likely to be felt first in other fixed-income sectors than G7 sovereign debt. We would be more concerned about the prospects for US high-yield bonds where default rates have been very low in the wake of support from the Federal Reserve than about US Treasuries.  

What is the outlook?

We have had conflicting signals from policymakers. The situation with regard to inflationary risk and whether it requires higher interest rates varies across countries. There are clearly some emerging markets where the rise in inflation will not be temporary and policymakers will be raising rates.

Economists are debating different theories on just how recent central bank policy will influence long-term economic growth and inflation. We anticipate central banks may at times struggle to retain their credibility. There is huge discussion about whether the pandemic has fundamentally changed the outlook for wage inflation in labour markets. Our view is that it is just too early to give a definitive answer.  

Expectations for US inflation in five years’ time have fallen after the Fed’s comments in June, but also on the view that growth in many countries is peaking or is close to peaking. We think the US Federal Reserve currently has a window of opportunity to talk about tapering. We will learn more at the next meeting of the FOMC on 27-28 July.  

While it is clear that rates will rise eventually, it is now also clear that markets are prepared for that eventuality. If tapering is the first step to policy tightening, it now looks less likely that there will be a ‘tantrum’ when the process actually kicks off.

Equally, the ground has been prepared in the case that inflation is not as temporary as (some) central bankers had made it out to be. Today, we find it hard to be very optimistic about prospects for global growth. That clouds the picture for the inflation outlook too.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Olivier de Larouzière. The post Market weekly – Fixed income: 2021 reflation trade, where art thou? (read or listen) appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

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Spread & Containment

You can now enter this country without a passport

Singapore has been on a larger push to speed up the flow of tourists with digital immigration clearance.

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In the fall of 2023, the city-state of Singapore announced that it was working on end-to-end biometrics that would allow travelers passing through its Changi Airport to check into flights, drop off bags and even leave and exit the country without a passport.

The latter is the most technologically advanced step of them all because not all countries issue passports with the same biometrics while immigration laws leave fewer room for mistakes about who enters the country.

Related: A country just went visa-free for visitors with any passport

That said, Singapore is one step closer to instituting passport-free travel by testing it at its land border with Malaysia. The two countries have two border checkpoints, Woodlands and Tuas, and as of March 20 those entering in Singapore by car are able to show a QR code that they generate through the government’s MyICA app instead of the passport.

A photograph captures Singapore's Tuas land border with Malaysia.

Here is who is now able to enter Singapore passport-free

The latter will be available to citizens of Singapore, permanent residents and tourists who have already entered the country once with their current passport. The government app pulls data from one's passport and shows the border officer the conditions of one's entry clearance already recorded in the system.

More Travel:

While not truly passport-free since tourists still need to link a valid passport to an online system, the move is the first step in Singapore's larger push to get rid of physical passports.

"The QR code initiative allows travellers to enjoy a faster and more convenient experience, with estimated time savings of around 20 seconds for cars with four travellers, to approximately one minute for cars with 10 travellers," Singapore's Immigration and Checkpoints Authority wrote in a press release announcing the new feature. "Overall waiting time can be reduced by more than 30% if most car travellers use QR code for clearance."

More countries are looking at passport-free travel but it will take years to implement

The land crossings between Singapore and Malaysia can get very busy — government numbers show that a new post-pandemic record of 495,000 people crossed Woodlands and Tuas on the weekend of March 8 (the day before Singapore's holiday weekend.)

Even once Singapore implements fully digital clearance at all of its crossings, the change will in no way affect immigration rules since it's only a way of transferring the status afforded by one's nationality into a digital system (those who need a visa to enter Singapore will still need to apply for one at a consulate before the trip.) More countries are in the process of moving toward similar systems but due to the varying availability of necessary technology and the types of passports issued by different countries, the prospect of agent-free crossings is still many years away.

In the U.S., Chicago's O'Hare International Airport was chosen to take part in a pilot program in which low-risk travelers with TSA PreCheck can check into their flight and pass security on domestic flights without showing ID. The UK has also been testing similar digital crossings for British and EU citizens but no similar push for international travelers is currently being planned in the U.S.

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International

This country became first in the world to let in tourists passport-free

Singapore has been on a larger push to speed up the flow of tourists with digital immigration clearance.

Published

on

In the fall of 2023, the city-state of Singapore announced that it was working on end-to-end biometrics that would allow travelers passing through its Changi Airport to check into flights, drop off bags and even leave and exit the country without a passport.

The latter is the most technologically advanced step of them all because not all countries issue passports with the same biometrics while immigration laws leave fewer room for mistakes about who enters the country.

Related: A country just went visa-free for visitors with any passport

That said, Singapore is one step closer to instituting passport-free travel by testing it at its land border with Malaysia. The two countries have two border checkpoints, Woodlands and Tuas, and as of March 20 those entering in Singapore by car are able to show a QR code that they generate through the government’s MyICA app instead of the passport.

A photograph captures Singapore's Tuas land border with Malaysia.

Here is who is now able to enter Singapore passport-free

The latter will be available to citizens of Singapore, permanent residents and tourists who have already entered the country once with their current passport. The government app pulls data from one's passport and shows the border officer the conditions of one's entry clearance already recorded in the system.

More Travel:

While not truly passport-free since tourists still need to link a valid passport to an online system, the move is the first step in Singapore's larger push to get rid of physical passports.

"The QR code initiative allows travellers to enjoy a faster and more convenient experience, with estimated time savings of around 20 seconds for cars with four travellers, to approximately one minute for cars with 10 travellers," Singapore's Immigration and Checkpoints Authority wrote in a press release announcing the new feature. "Overall waiting time can be reduced by more than 30% if most car travellers use QR code for clearance."

More countries are looking at passport-free travel but it will take years to implement

The land crossings between Singapore and Malaysia can get very busy — government numbers show that a new post-pandemic record of 495,000 people crossed Woodlands and Tuas on the weekend of March 8 (the day before Singapore's holiday weekend.)

Even once Singapore implements fully digital clearance at all of its crossings, the change will in no way affect immigration rules since it's only a way of transferring the status afforded by one's nationality into a digital system (those who need a visa to enter Singapore will still need to apply for one at a consulate before the trip.) More countries are in the process of moving toward similar systems but due to the varying availability of necessary technology and the types of passports issued by different countries, the prospect of agent-free crossings is still many years away.

In the U.S., Chicago's O'Hare International Airport was chosen to take part in a pilot program in which low-risk travelers with TSA PreCheck can check into their flight and pass security on domestic flights without showing ID. The UK has also been testing similar digital crossings for British and EU citizens but no similar push for international travelers is currently being planned in the U.S.

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Government

Analysts issue unexpected crude oil price forecast after surge

Here’s what a key investment firm says about the commodity.

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Oil is an asset defined by volatility.

U.S. crude prices stood above $60 a barrel in January 2020, just as the covid pandemic began. Three months later, prices briefly went negative, as the pandemic crushed demand.

By June 2022 the price rebounded all the way to $120, as fiscal and monetary stimulus boosted the economy. The price fell back to $80 in September 2022. Since then, it has bounced between about $65 and $90.

Over the past two months, the price has climbed 15% to $82 as of March 20.

Oil prices often trade in a roller-coaster fashion.

Bullish factors for oil prices

The move stems partly from indications that economic growth this year will be stronger than analysts expected.

Related: The Fed rate decision won't surprise markets. What happens next might

Vanguard has just raised its estimate for 2024 U.S. GDP growth to 2% from 0.5%.

Meanwhile, China’s factory output and retail sales exceeded forecasts in January and February. That could boost oil demand in the country, the world's No. 1 oil importer.

Also, drone strokes from Ukraine have knocked out some of Russia’s oil refinery capacity. Ukraine has hit at least nine major refineries this year, erasing an estimated 11% of Russia’s production capacity, according to Bloomberg.

“Russia is a gas station with an army, and we intend on destroying that gas station,” Francisco Serra-Martins, chief executive of drone manufacturer Terminal Autonomy, told the news service. Gasoline, of course, is one of the products made at refineries.

Speaking of gas, the recent surge of oil prices has sent it higher as well. The average national price for regular gas totaled $3.52 per gallon Wednesday, up 7% from a month ago, according to the American Automobile Association. And we’re nearing the peak driving season.

Another bullish factor for oil: Iraq said Monday that it’s cutting oil exports by 130,000 barrels per day in coming months. Iraq produced much more oil in January and February than its OPEC (Organization of Petroleum Exporting Countries) target.

Citigroup’s oil-price forecast

Yet, not everyone is bullish on oil going forward. Citigroup analysts see prices falling through next year, Dow Jones’s Oil Price Information Service (OPIS) reports.

More Economic Analysis:

The analysts note that supply is at risk in Israel, Iran, Iraq, Libya, and Venezuela. But Saudi Arabia, the UAE, Kuwait, and Russia could easily make up any shortfall.

Moreover, output should also rise this year and next in the U.S., Canada, Brazil, and Guyana, the analysts said. Meanwhile, global demand growth will decelerate, amid increased electric vehicle use and economic weakness.

Regarding refineries, the analysts see strong gains in capacity and capacity upgrades this year.

What if Donald Trump is elected president again? That “would likely be bearish for oil and gas," as Trump's policies could boost trade tension, crimping demand, they said.

The analysts made predictions for European oil prices, the world’s benchmark, which sat Wednesday at $86.

They forecast a 9% slide in the second quarter to $78, then a decline to $74 in the third quarter and $70 in the fourth quarter.

Next year should see a descent to $65 in the first quarter, $60 in the second and third, and finally $55 in the fourth, Citi said. That would leave the price 36% below current levels.

U.S. crude prices will trade $4 below European prices from the second quarter this year until the end of 2025, the analysts maintain.

Related: Veteran fund manager picks favorite stocks for 2024

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