August was a month to remember. Volatility returned as investors had plenty of news to digest.
The Federal Reserve cut rates on July 31 for the first time since 2008. Chairman Jerome Powell disappointed market participants, however, during his press conference when he called the rate cut a “mid-cycle adjustment.” This suggested additional rate cuts were not the base case.
U.S.-China trade tensions intensified when the U.S. announced a fresh round of tariffs on China’s exports beginning September 1. In response, China allowed the yuan to breach a key psychological level, sending global risk assets lower and volatility sharply higher. The U.S. Treasury responded by designating China as a currency manipulator.
And all this happened in just the first week of August!
On August 23, China issued retaliatory tariffs on U.S. exports. The U.S. responded with intentions to implement incremental tariffs on December 1. With the trade war entering its 20th month, the chasm between both sides seems wider than ever.
Simultaneously, non-U.S.-based investors are grappling with a fast-growing universe of negative fixed income rates. According to Bloomberg [1], more than $11 trillion in world bonds traded at negative rates in June. By the end of August, MarketWatch [2] reported the total grew to almost $17 trillion.
The universe of bonds with a negative yield is fast growing and now includes corporate bonds. CNN Business [3] reported that on August 30, Siemens, the German industrial conglomerate, issued two-year debt at -0.315%.
Bond yields are still positive for U.S.-based investors after hedging foreign exchange rate risk, but the expanding universe of bonds with negative yields sends cautionary signals regarding both growth expectations and global liquidity conditions.
Investor risk sentiment cooled as the U.S.-China trade war began to heat up last month. U.S. equities, as measured by the S&P 500 Index, fell 2% in August, but performed better than international developed non-U.S. (MSCI EAFE Index, -2.6%) and the MSCI Emerging Market Index (-4.9%).
Real assets held up relatively well but were not immune to the risk-off sentiment. Master Limited Partnerships (“MLPs”) fell in line with spot WTI oil prices, while Real Estate Investment Trusts [4] (“REITs”) gained 3.4%. Falling rates typically benefit REITs as the lower yield environment creates demand for the income they provide and increases demand for real estate.
Despite the recent uptick in bearish sentiment toward risk assets, market participants are well aware of U.S.-China trade tensions and slowing global growth. As such, investor risk sentiment may be skewed too much to the downside. Any improvement on those fronts or a dovish Fed pivot could change the trajectory of risk assets faster than investors can react. Therefore, investors should continue to ensure that their unique portfolio objectives align with their risk tolerances.
The Federal Reserve cut rates for the first time since 2008, ending its balance sheet reduction program in August — two full months ahead of schedule. The cut aimed to ease monetary conditions, but market participants were disappointed that Chairman Powell did not signal further easing.
Last summer, a few prominent investors publicly called for the low in yields and warned that inflation and higher yields would dominate 2019. Over the last 12 months, those forecasts did not come to fruition. Fixed income investments have been a key source of positive returns for investors amid rising uncertainty. The Bloomberg Barclays Aggregate Bond Index gained 2.6% in August and 10.2% over the last 12 months as heightened risk aversion spurred a flight to quality. U.S. Treasury yields fell more than 105 basis points across curve over the last 12 months, and the 30-year Treasury yield even fell below 2% for the first time in history.
While a bounce higher in yields would not be surprising after such a sharp move, we believe the trend lower appears intact as global central banks take steps to ease monetary conditions.
Depth Gauge
Ten-year government bond yields reach new lows as central banks signal further monetary accommodation.
Source: Bloomberg
Federal fund futures now forecast just over two additional 25 basis point cuts this year, and four rate cuts by August 2020. While the Federal Reserve and European Central Bank policies grab headlines, it’s worth noting that 11 central banks cut rates in August to support slowing economic growth.
In summary, August was a month to remember. U.S.-China trade tensions appeared to ratchet out of control, investors lacked confidence that Fed officials will proactively tune monetary policy, and global growth continues to slow. The increasing amount of bond yields with negative interest rates poses unique challenges for foreign investors but hinder U.S. rates from a sustained upside, breakout barring a sharp reversal in economic conditions.
Right now, we do not find any compelling reasons to justify overriding our asset allocation methodology despite elevated uncertainty. Investors should remain patient and adhere to a well-constructed, diversified investment portfolio anchored to long-term goals and time horizon.
As always, feel free to reach out to any advisor at Fi3 if you have questions about your portfolio.
1. World of Negative Debt Now Tops One-Fifth of the Global Market. 3 June 2019.
2. That near–$17 trillion pile of negative-yielding global debt? It’s a cash cow for some bond investors. 22 August 2019.
3. Siemens just borrowed billions. Its corporate bonds had the lowest yields ever. 30 Aug 2019.
4. Bloomberg. REITs: FTSE NAREIT Equity REITs Index USD.