The below commentary from Julius Baer will talk about the current state of US government bonds, dropping oil prices and the performance of gold.
US Government Bonds: Even more under the control of the Fed
The US Federal Reserve (Fed) is increasing its influence on the US Treasury market. We still wait for the US central bank to enter the corporate bond market and to lower credit spreads, and thus maintain our preference for moderate credit risk.
Jim Bianco of Arbor Research, a well-known observer of the US bond market, concludes that US Treasury bonds will remain on the market on average only 30 minutes, the time span between the end of the Treasury refinancing auctions and the Fed New York purchase auction. Given that the latter has the authority for de facto unlimited purchases, the only question is on the yield level the two parties agree upon. In a further step to complete its control over the US Treasury market, the Fed offers refinancing repos to foreign central banks. Foreign central banks have sold USD 121 billion of Treasuries according to the weekly Fed figures of custody holdings. With the generous offering of a refinancing facility, the foreign central bank can use their Treasury holdings as collateral and get USD funding without selling at favourable conditions. With this, the Fed has sidelined one more actor on the Treasury market. It is only a question of time until the Fed has the legal framework done to enter the corporate bond market. We expect credit spreads of investment-grade bonds to compress once the Fed starts its purchases in earnest.
Markus Allenspach, Head Fixed Income Research, Julius Baer
Oil: Pricer for production shut down
Oil prices dropped to new multi-year lows earlier this week as oil demand drops of a cliff with the global economy grinding to halt. Brent oil prices at around USD 25 per barrel translate into much lower prices for regional grades, forcing production shut-ins around the globe. We see oil prices continuing to swing wildly in the very near term, followed by a slow recovery beyond USD 30 per barrel by mid-year.
Oil prices remain heavily depressed, as large parts of the global economy are coming to standstill and oil demand is dropping of a cliff. Front-month futures prices dropped to multi-year lows earlier this week ahead of the contract expiry, which raised headlines. The oil business rests on comparably long investment decision times and thus supply reacts to changes in demand only with a time lag. In consequence, the price moves needed to force production adjustments to changed market conditions can be very wild, just as we witness these days. Current price levels at around USD 25 per barrel translate into much lower oil prices relevant for physical trading in some regions. Oil prices for certain Canadian grades, for example, trade below USD 10 per barrel, of course also because of their minor quality. The oil market has repriced to levels were producers are forced to shut in output as even cash costs are no longer covered. While the pain immediately hits in the North American shale business, where cash and total costs are closer together, the suffering of the petro-nations comes more slowly but is likely to be longer-lasting. With the market mood as bearish as it gets and prices forcing a supply reduction, we see overall more upside than downside from today’s levels for the longer term. However, the double shock of the pandemic and oil politics suggests that oil prices will continue to swing wildly in the very near term. Investors should note that the pronouncedly upward-sloping futures curve limits the return potential of positions geared towards higher oil prices.
Norbert Rücker, Head Economics and Next Generation Research, Julius Baer
Gold: Another strange day
While there were some days during which gold did not perform as expected during the corona crisis, overall it once again underpinned its status as a safe haven. As the global recession unfolds, we still see more upside than downside for gold and maintain our Constructive view. Meanwhile, coin price premiums have shot up, reflecting constraints to air travel and refinery closures but not pointing to a shortage of gold in general.
Since the outbreak of the corona crisis in financial markets, there were some days during which gold did not perform as expected. Its price performance seemed strange at first sight but could be explained by forced selling or massive moves in real US bond yields. Yesterday was another strange day with prices down almost 3%. Looking across gold’s typical drivers, neither the US dollar nor US bond yields nor the mood in financial markets are able to explain such a decline. One possible but not very satisfying explanation is quarter-end rebalancing of portfolios. That said, gold once again underpinned its status as a safe haven during the current corona crisis, rising slightly since the outbreak while equities fell heavily. As the global recession unfolds and as uncertainties remain very high in financial markets, we still see more upside than downside for gold and maintain our Constructive view. However, only if the situation moves out of hand and the expected short and sharp recession turns into a longer-lasting depression, gold’s all-time high could come into reach. Meanwhile, the constraints to global air travel and the closures of gold refineries are showing up in product price premiums. A case in point is the American Eagle coin, which is sold at a 6% premium to the gold price, the highest level since the Great Financial Crisis. However, this does not point to a shortage of gold in general but of certain products in particular. Most importantly, these premiums should not be permanent.
Carsten Menke, Head Next Generation Research, Julius Baer