On March 16, I had written an article entitled ‘MGS sell-off gathers momentum’ in which I had explained how the overall downward trend in the prices of Malta Government Stocks (MGSs) had persisted in the first few months of 2017 following the initial slump triggered by the election of Donald Trump as President of the US in early November 2016.

Indeed, the Rizzo Farrugia MGS Index – which gauges the daily movements in the indicative opening bid prices of MGSs quoted by the Central Bank of Malta (CBM) – reached a two-year low of 1,107.572 on March 14 from an all-time high of 1,182.272 points recorded on October 24, 2016 (i.e. just prior to the US election).

Bond markets were caught by surprise by the increased momentum of economic recovery within the eurozone during the first few months of the year. In fact, during the monetary policy meeting held on March 9, the European Central Bank increased both its growth and inflation forecasts for 2017 and also for 2018. Furthermore, during the customary press conference following the conclusion of the ECB Governing Council meeting, president Mario Draghi said that the ECB no longer had a “sense of urgency” to take further action on monetary stimulus.

Despite the renewed economic confidence, eurozone sovereign yields started to reverse their previous gains (bond prices advanced), largely reflecting political uncertainty in the US.

In fact, during the fourth week of March, the three primary equity indices in the US – namely, the S&P 500, the Dow Jones Industrial Average and the Nasdaq – recorded their worst weekly performance in several months while the 10-year benchmark German Bund yield fell abruptly from a near 14-month high of 0.51 per cent recorded on March 14 (coinciding with the two-year low of the RF MGS Index) to a low of 0.153 per cent on April 18 – the lowest since January 3.

During this four-week period, the RF MGS Index surged by 1.73 per cent to 1,126.757 points on April 11, reflecting the sharp decline in eurozone yields. By way of example, the indicative bid price quoted by the CBM for the longest-dated stock in issue – i.e. the 2.40 per cent MGS 2041 – gained 395 basis points to 100.2 per cent from an all-time low of 96.25 per cent registered on March 14. Likewise, the indicative prices for two of the longer-dated MGSs issued last year – i.e. the 2.5 per cent MGS 2036 which was issued in February 2016 at a price of 101.50 per cent and the 2.10 per cent MGS 2039 which was issued in October 2016 at 102.50 per cent – also advanced by nearly 400 basis points to 104.23 per cent and 96.99 per cent from their mid-March 2017 record lows of 100.43 per cent and 93.08 per cent respectively. Furthermore, the indicative price for the longest-dated MGS issued last February – i.e. the 2.2 per cent MGS 2035 which was issued at a price of 100.25 per cent – advanced by 387 basis points to 102.19 per cent from a record low of 98.32 per cent also recorded on March 14.

Between mid-April and mid-May 2017, bond market movements were impacted by the exit polls of the French presidential eletion. As the polls constantly projected a resounding win for the reformist 39-year-old former economy minister Emmanuel Macron, eurozone sovereign yields started to recover (bond prices fell) amid improving sentiment that the French candidate can assist in lifting Europe towards sustained economic growth. In fact, the 10-year German Bund yield jumped back up towards the 0.50 per cent level again, touching a high of 0.461 per cent on May 11 from 0.153 per cent only three weeks earlier.

Investors ought to be extremely vigilant

Meanwhile, economic developments elsewhere continued to be largely positive. Indeed, on April 19, the IMF raised its forecasts for world GDP growth while China registered the sharpest Q1 GDP growth in eighteen months. Within the single currency area, GDP grew at an annualised rate of two per cent in the first quarter, much better than that of the US which rose by only 0.7 per cent – the weakest since early 2014.

The recovery in eurozone sovereign yields was short-lived as political uncertainty in the US resurfaced. After President Donald Trump threatened to shut down the US government next September as a form of retaliation to the clearance of a spending bill by Congress, on May 9, Mr Trump abruptly fired FBI director James Comey. Trump’s reputation took another blow after it was revealed that he reportedly met Russia’s ambassador to the US as well as the Russian foreign minister and shared highly confidential security information with them.

Political uncertainty in the UK also impacted bond market movements after Prime Minister Theresa May suffered an unexpected setback during the early general election at the start of June. The Conservative Party fell short of a majority within the House of Commons, prompting vociferous criticism towards May’s decisions including calls for her resignation and casting doubt over the smooth transition of the UK out of the EU.

As a result, eurozone sovereign yields quickly reversed the previous recovery and the 10-year German Bund yield dropped back towards the 0.20 per cent level again by mid-June 2017 from close to 0.50 per cent a month earlier. On June 22, the RF MGS Index reached a five-month high of 1,137.064 points – representing a gain of 2.66 per cent over the two-year low of 1,107.572 points recorded on March 14.

During this three-month period, the indicative bid price quoted by the CBM for the 2.40 per cent MGS 2041 increased by 673 basis points to 102.98 per cent from the mid-March 2017 all-time low of 96.25 per cent. The 2.5 per cent MGS 2036 and the 2.10 per cent MGS 2039 posted similarly robust gains while the 2.2 per cent MGS 2035 reached a record high of 105.16 per cent on June 22 – also representing a gain of almost seven percentage points over the mid-March 2017 low of 98.32 per cent.

However, most of the solid gains in MGS prices registered between mid-March 2017 and the third week of June were quickly wiped out in a matter of less than three weeks. By July 10, almost all MGSs with maturities of nine years and over slumped by more than 425 basis points. In particular, the MGSs with maturities between 13 and 17 years (i.e. those bonds maturing between 2030 and 2034) dropped by more than 500 basis points.

The most recent sell-off in MGSs reflects the latest actions taken by three of the world’s most influential central banks. In the US, despite some signs of economic growth fatigue and disappointing inflation data, the Federal Reserve lifted the range for its benchmark interest rate by a further 25 basis points (the second time this year) on June 14 to between one per cent and 1.25 per cent. The Fed maintained its outlook for a total of three rate hikes this year, largely on the back of encouraging growth in wages and an unemployment rate at its lowest level in 10 years.

Moreover, on June 15, the Monetary Policy Committee (MPC) of the Bank of England left its monetary policy unchanged. However, in a significant turn of events, three MPC members surprised financial markets by voting for a rise in interest rates amid persistently higher inflation in the UK in recent months partly due to the weaker British pound against a basket of currencies. Subsequently, BoE governor Mark Carney also stated that a rise in interest rates in the UK was likely to be needed and that therefore this matter would be debated “in the coming months”.

However, the major influence which forced the benchmark 10-year German Bund yield to shoot to an 18-month high of over 0.60 per cent was widespread concern that the ECB might tighten its monetary policy further in the coming months after reducing the size of its monthly asset-purchase programme by €20 billion to €60 billion-a-month in December 2016.

The ECB’s quantitative-easing (QE) programme is currently due to end in December 2017 but some international financial commentators continued to speculate that the ECB might even consider increasing its deposit facility (which currently stands at a record low of -0.4 per cent) before the end of its QE programme as comments made by Draghi confirmed that “deflationary forces have been replaced by reflationary ones”.

On the other hand, however, the ECB president also reiterated that any change in the bank’s monetary policy would be gradual as “considerable” monetary support is still needed with core inflation remaining below the ECB target level of close but below two per cent. Further comments made by the ECB chief economist Peter Praet echoed Draghi’s discretion.

Meanwhile, minutes of the ECB monetary policy meeting held on June 8 published two weeks ago showed that members of the ECB Governing Council discussed the possibility of the ECB removing its long-running promise to extend, if necessary, its asset-purchase programme. Nonetheless, the Governing Council decided otherwise as “it was necessary to avoid signals that could trigger a premature tightening of financial conditions”.

The very high levels of volatility in eurozone sovereign yields, and hence in prices of MGSs, seen in recent months is another timely reminder to local retail investors of the price risk in holding on to long-term MGSs. It is now becoming more apparent that the end to the era of ultra-loose monetary policy worldwide is gradually taking shape. In fact, on July 12,  the Bank of Canada was the first major central bank after the US Federal Reserve to raise interest rates. Meanwhile, political developments across the world also continue to play a very influential role in determining the course of movements across financial movements. As such, investors ought to be extremely vigilant of all the important developments impacting their investment portfolios.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (Rizzo Farrugia) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. Rizzo Farrugia, its directors, the author of this report, other employees or Rizzo Farrugia on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither Rizzo Farrugia, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2017 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

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