STRATEGY NOTE:

BONDS AND FX STRATEGY

APPROACHING ‘RUBICON LEVELS’

MEHUL DAYA NEELS HEYNEKE

Strategist Senior Strategist
MehulD@Nedbank.co.za Nheyneke@Nedbank.co.za

GLOBAL BOND YIELDS ON THE MOVE AMID TIGHTER GLOBAL FINANCIAL CONDITIONS
• The first half of 2018 was dominated by tighter global
financial conditions amid the contraction in Global $-
Liquidity, which resulted in the stronger US dollar
weighing heavily on the performance of risks assets,
particularly EM assets and, of course locally, on our
currency (-15% YTD vs USD), bonds (+60bps YTD, R186)
and equity market (-8% YTD, Top40).
• Global bond yields are on the rise again, led by the US
Treasury yields, which as we have highlighted in
numerous reports, is the world’s risk-free rate.
• The JPM Global Bond yield, after being in a tight
channel, has now begun to accelerate higher. There is
scope for the JPM Global Bond yield to rise another 20-
30bps, close to 2.70%, which is the ‘Rubicon level’ for
global financial markets, in our view.
• If the JPM Global Bond yield rises above 2.70%, the cost
of global capital would rise further, unleashing another
risk-off phase. Our view is that 2.70% will hold, for the
time being.
• We believe the global bond yield will eventually break
above 2.70%, amid the contraction in Global $-Liquidity.

Source: BBG, Nedbank CIB

GLOBAL LIQUIDITY CRUNCH NEARING AS GLOBAL YIELD CURVE FLATTENS/INVERTS

• A stronger US dollar and the global cost of capital rising
is the perfect cocktail, in our opinion, for a liquidity
2.5 Global yield curve crunch.
%
• Major liquidity crunches often occur when yield curves
2 Greenspan CB stimulus around the world flatten or invert. Currently, the global
rate cuts Commodity yield curve is inverted; this is an ominous sign for the
1.5 cycle global economy and financial markets, especially over-
valued stocks markets like the US.

1 • The US economy remains robust, but we believe a

global liquidity crunch will weigh on the economy.
Taper Hence, we believe a US downturn is closer than most
0.5 market participants are predicting.
Fragile 5
0

Mexico/ GFC ?
-0.5 Russia crisis EM carry-trade
S&L EM $-debt
Asian
-1 Share buyback-fuelled US
crisis
stock market
US recession
-1.5
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020
Source: Spread between 1-5yr to 5-10yr maturity buckets of JPM Global Bond index, Nedbank CIB

4 OCTOBER 2018 | PAGE 1

 STRATEGY NOTE:
BONDS AND FX STRATEGY
APPROACHING ‘RUBICON LEVELS’

GLOBAL VELOCITY OF MONEY WOULD LOSE MOMENTUM

• The traditional velocity of money indicator can be
Velocity of Money Indicator calculated only on a quarterly basis (lagged). Hence,
8 we have developed our own velocity of money
35
BRICS term indicator that can be calculated on a monthly basis.
coined

6
• Our Velocity of Money Indicator (VoM)is a
proprietary indicator that we monitor closely. It is a
25 ECB QE
China M2 modernised version of Irving Fisher’s work on the
30%yoy Abenomics
$-liquidity 4 Quantity Theory of Money, MV=PQ.
15 QE 2/
LTRO
squeeze • We believe it is a useful indicator to understand the
'animal spirits' of the global economy and a leading
QE 1 2
5 indicator when compared to PMIs, stock prices and
business cycle indicators, at times.

-5
Taper 0 • The cost of capital and Global $-Liquidity tend to lead
EZ debt crisis Tantrum
the credit cycle (cobweb theory), which in turn filters
CNY devalue
through to prospects for the real economy.
-2
-15 G20
"Shanghai • Prospects for global growth and risk assets are likely
Accord" to be dented over the next 6-12 months, as the rising
-25 -4 cost of capital globally will likely weigh on the global
economy’s ability to generate liquidity – this is
Subprime
Tech bubble Metldown already being indicated by our Global VoM indicator
-35 -6
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
VoM indicator (RHS, yoy%) OECD Global Leading Indicator (LHS,yoy%)

Source: Nedbank CIB, VoM indicator = Changes in global yield curves, bank stock prices, corporate
spreads, money multiplier and commodity prices;

SUPPORTS TO HOLD, FOR NOW…

• As the JPM Global yield targets 2.70%, we believe local
bonds will remain under pressure, targeting close to the
9.40% level. We, however, believe 9.35% will not be
breached.
• We expect the rand to consolidate around 14.70,
potentially targeting 15.00 in the short term, but we do
not expect weakness above 15.00 to be sustained.
• In the next phase of Global $-Liquidity shortage, we
expect local bonds to climb above 10%, targeting
10.50%, and the currency to breach 15.00, targeting
15.80.

Source: BBG, Nedbank CIB

Link to Nedbank CIB Disclaimer

4 OCTOBER 2018 | PAGE 2