PBoC surprised markets

Beginning of August, the People Bank of China (PBoC) raised the official USDCNY fix around which the currency is allowed to trade during the day (+/-2% trade band). This move surprised markets by changing the rules for calculating its currency fixing leading to a significant drop of the CNY/USD; the biggest one-day decline since 1994. The adjustment was about 1.9%, 1.6% and 1.1% on Tuesday, Wednesday and Thursday respectively.

The PBoC’s intervention has rippled accross global financial markets with most Asian currencies, commodity prices and US treasuries and US and European government bond yields down sharply.

Gain exposure to EMU non core after Greek relief

Sovereign markets performed well in July, with non-core sovereign curves outperforming. After a long and tense Euro summit, an agreement was finally reached on the outlines of a large reform programme for Greece intended to ensure their Euro-area membership. The different legislative hurdles to secure bridge financing and to start negotiations on a third programme were also passed. The aid should size close to EUR 85 bn. and will be partially used for bank sector recapitalisation. Looking forward both political and programme execution risks remain present while Greek debt sustainability is not solved.

The ECB increased the ELA ceiling for Greek banks, permitting the Greek bank to re-open. The pace of PSPP purchases by the ECB decreased, bringing July total purchases at 61.5 bn (with ABS and covered bonds).

On the inflation front, data should improve but the recent oil decrease and the slowdown in China and emerging markets will clearly temper global inflation pressures.

In this context, European sovereign rates decreased, as German yields closed the month at 0.64% on the 10Y, while non-core yields outperformed, bringing 10Y Spanish, Italian and Portuguese yields respectively at 1.84%, 1.77% and 2.39%. We further increased our non-core exposure via Spain, Italy & Portugal. We also increased back our exposure on Lithuania, that lagged in terms of performance. Regarding linkers, we preferred to stay sidelines, waiting for better investment opportunities, as carry, oil, liquidity and global inflation dynamics are not supportive. Directionally, we have a slight negative stance on the 10-year German rate on the back of expensive valuation signals. The very long positioning of investors is also a supportive factor to anticipate a rise in yields.

Flattening on the US curve

The US business cycle remains robust. However, with the Chinese slowdown, many investors do not expect a rate hike for the Fed’s September meeting. Yet, we are keeping our flattening trade on the US. We are short the 5-year part of the curve and long the 30-year. Historically, the 5/30 segment seems very steep before an upcoming rate hike (Chart 2).