China kicks off ‘Northbound’ bond trading on Monday
Six big themes likely to dominate thinking of investors and traders in the coming week
1. It’s official, bonds can go north
The People’s Bank of China and Hong Kong Monetary Authority said on Sunday trial operation of “Northbound” trading of Bond Connect will start on Monday, confirming information shown on the program website on Friday. Trading through the program will start “Northbound”, meaning foreign investors will be able to buy and sell Chinese bonds. The PBOC and HKMA said in the joint statement that they have agreed on the principles of cross-boundary supervisory cooperation under Bond Connect. “For Northbound trading, the relevant regulations, policies and operational and supervisory arrangements have been finalized, technical systems are ready, and market promotion as well as on-boarding are both under way,” the statement added.
2. A new quarter, a new era?
Q3 is shaping up to be a highly uncertain quarter for investors. Central bankers are suddenly revealing their talons and even doves like Andy Haldane at the Bank of England are turning hawkish. If this shift really is the beginning of the end of cheap money globally, expect market volatility to rise. Q2 saw the VIX index of implied volatility on Wall Street hit its lowest level ever, US bond market volatility within inches of all-time lows and currency market volatility fall to multi-year lows. World stocks hit all-time highs and bonds did well too as markets bet the Fed wouldn’t tighten policy as aggressively as they had indicated.
The hunt for yield was such that Argentina sold a 100-year bond at less then 8%. Argentina has been in a state of default for more than half of all days since 1980, yet investor demand for the bond was red hot. Elsewhere, the euro rose 7%, its best quarter since 2010, the dollar had its worst quarter since 2010, and oil briefly entered bear market territory (down 20%). If central bankers’ “hawk talk” persists, expect these moves to reverse or slow, and volatility to rise in Q3, a period already marked by summer holidays and lighter liquidity.
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3. Volatile times
There is a deep suspicion among the major players in the currency market that this week’s dollar sell-off may have been overdone. Some might think the European Central Bank sees matters similarly, judging by Wednesday’s attempts to walk back the move that followed ECB chief Mario Draghi’s speech on Tuesday. Official dollar interest rates are still way higher than anybody else’s. The chances of another rate rise this year have risen, not fallen, to around 50%, and there will be more next year while the ECB is still concerned chiefly with reining in QE. In that light, some say the scale of the move this week is just a reflection of otherwise super-low volatility in FX markets; whenever there’s a chance of some action, everyone piles in, and the moves are overblown. The dollar, they say, still looks very attractive against the yen, even if parity with the euro is a distant dream. And if the data, the Bank of Canada and the Riksbank disappoint over the next 10 days, there may even be a full retracement.
4. Beginning of the end?
“Draghi’s Sintra speech will probably be remembered as the beginning of the end of QE.” So says Commerzbank. They are not alone, with bonds and stocks behaving as though investors are preparing for tapering. When the ECB publishes the minutes of its latest policy meeting on Thursday, market participants will be keeping a close eye on how far the debate has gone – some are expecting the tapering announcement to come in September and the winding down of the bond-buying scheme in 2018. Strong German inflation numbers and an increase in core inflation – which strips out the effect of oil price increases – are all pointing towards a brightening euro zone economy and fanning the flames further as investors focus on the unwinding of extraordinary stimulus.
5. Deadline for Qatar
The diplomatic crisis surrounding the tiny Gulf state of Qatar shows no sign of abating. The feud erupted around three weeks ago, when Saudi Arabia, the United Arab Emirates, Bahrain and Egypt severed diplomatic and travel links with Qatar, accusing it of supporting terrorism and courting regional foe Iran. Doha rejects the allegations, but the rift has ignited a regional crisis between the US allies and weighed on markets across the region. The four Arab powers have come up with a list of demands and have set a deadline of around Monday next week for Doha to agree to demands such as shutting television channel Al Jazeera and reducing ties with Iran. Publicly, Doha has shown little sign of complying, and the four states have said they could impose fresh sanctions if their demands are not met. All this has weighed on the Qatari riyal, which has been trading far below its peg to the dollar.
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6. Nice to meet you
The G20 holds a summit meeting in Hamburg at the end of the coming week, which, depending on the amount of heat and light generated, could provide useful signposts for markets. Summit host Angela Merkel, the German Chancellor, has promised to fight for free trade and to press on with multilateral efforts to combat climate change. US President Donald Trump, who has initiated the withdrawal of the United States from the Paris climate accord, will, according to an adviser, demand stronger action on steel industry overcapacity. Noteworthy meetings are also scheduled between Trump and Russian President Vladimir Putin and Trump and Mexican President Pena Nieto. Building bridges rather than walls?