Daily Agenda: Risk Reassessment Drives Up Bond Yields

Chinese and U.K. manufacturing data disappoint; Aramco announces major overhaul; LinkedIn shares sell off after guidance lowered.


Martin Leissl

Global bond markets have come under selling pressure recently. Safe havens such as Germany are feeling the pressure, with German ten-year Bund yields rising as much as 30 basis points over the past two weeks and U.S. comparable yields climbing roughly 20. These marginal retreats do not appear to have a central bank policy catalyst, despite recent announcements from the Federal Reserve and the European Central Bank. On one hand, the fact that oil prices appear to have recovered somewhat suggests that some investors are recalibrating inflation expectations. On the other hand, concerns over liquidity have increasingly garnered headlines in the financial media. Whatever the root cause, sentiment across the curve appears to be taking a slight shift.

Aramco to be restructured. The Saudi Arabian Oil Company, better known as Aramco, will undergo a major structural overhaul, unveiled in a surprise announcement today by the country’s Supreme Economic Council. The state-run company will be separated from the nation’s petroleum ministry. Saudi state media specifically cited newly installed 30-year-old Deputy Crown Prince Mohammed bin Salman, who is also Saudi Arabia’s defense minister, as being the driving force behind the change-up. King Salman announced a major reshuffle of the royal succession line earlier this week, which included elevating his son, Mohammed bin Salman, to second in line to the throne.

U.K. posts sluggish manufacturing numbers. Markit final manufacturing purchasing manager index levels for the U.K. today registered at a seven-month low of 51.9. This represents a major decline from March when the headline index came in at 54.4 and much weaker than consensus analysts’ forecasts, which actually called for an improvement for the month. Soft export demand in particular was cited as a primary driver behind the disappointing figures.

Tensions rise in the Strait of Hormuz. In response to the seizure of a Marshall Islands-flagged vessel by Iranian naval forces earlier this week, the U.S. Navy has begun escorting U.S. commercial shipping in the region (through the countries’ Compact of Free Association, the U.S. has responsibility for the the Pacific Island nation’s international defense). Following the decision in April to send a task force to support a Saudi-led coalition specifically to prevent Iranian ships from supplying support to Shia rebels in Yemen, this is a sign of more strained relations between Tehran and Washington.

Chinese manufacturing data. April manufacturing purchasing manager index data released today by the National Bureau of Statistic registered slightly above consensus forecasts by economists. While an improvement for the month, the indicator is seen as confirmation of the earlier unofficial purchasing managers’ index data released by HSBC, which indicates that at the very least, the manufacturing sector in China is extending a trend of slowing activity.

Earnings season continues. In an announcement after equity markets closed yesterday, social media company LinkedIn Corp. slashed its full 2015 forecast to $1.90 per share citing U.S. dollar strength and waning advertising revenues. LinkedIn’s stock price fell by double digits in aftermarket trading. Prior to the announcement, the company’s shares had declined by 60 percent in the trailing 12-month period. Ratings agency Moody’s Corp. issued earnings for the first quarter with a year-over-year increase of 12 percent in operating income, reaffirming full-year guidance. The company cited the surge in mergers and acquisitions as driving more high-grade bond issuance as a driver for their ratings franchise.

Portfolio Perspective: China and Commodities DemandKevin Norrish, Suki Cooper and Chi Zhang, Barclays

China’s commodity demand has been surprisingly strong so far this year, at odds with weak economic growth indicators. Increased infrastructure spending, restocking on low prices and strong growth in the transport sector have all played a part. We expect demand growth for most commodities to slow over the rest of the year but overall, expect China to have a greater appetite for commodities this year compared to last.

The commodity data are especially encouraging, considering weakening in closely followed Chinese macroindicators and a very weak 2014, which included oil demand growth slowing to its lowest since the early 1990s.

Not all of China’s commodity imports are expanding, however. Coal imports, for example, are incredibly sluggish — down more than 40 percent year-over-year during the first quarter — but that is related to a big increase in domestic output, improvements in domestic coal transport infrastructure and the rising use of renewable energy sources, rather than any particular weakness in domestic power demand.

Indeed, what stands out in the recent data is a consistent picture of commodity demand strength across a variety of markets. So what is driving it, and will it prove sustainable?

First, rising government infrastructure investment is likely an important factor. At the end of 2014, the central government approved 300 investment projects for 2015, valued nominally at 7 trillion yuan ($1.13 trillion).

Second, the positive import and demand data for many commodities could be getting a boost from stock-building, encouraged by the dip in prices. China has a track record of getting very active in markets such as copper and oil on large price dips. This could be just another sustained bout of bargain-hunting.

Finally, some of the early-year strength in demand for certain commodities might indicate that the government’s desire to encourage a more consumption-led and less polluting growth model is having an effect in certain areas. Demand for commodities linked to the private transport sector such as gasoline, jet fuel, palladium (for autocatalysts) and even steel could benefit greatly. It is possible that recent demand strength for some of these commodities reflects this. Cleaner burning and much cheaper LPG transport fuel is one of the strongest components of China’s oil demand growth so far this year, likely also linked to the changing use of transport fuels.

Will China’s first-quarter commodity demand strength last? Extra government spending on infrastructure is real, as is the growth in car ownership and demand for air travel. A combination of low prices and restocking has been important. Neither will last, however, so some slowdown should be expected.

Kevin Norrish, Suki Cooper and Chi Zhang are strategists for Barclays, based in London, New York and Hong Kong respectively.