Institutional investors, far from rushing to safety in the midst of the turbulent end to 2018, are selling Treasuries, according to an analysis from State Street.
State Street recently issued a new Bond Compass report aggregating fixed income flow data to capture behavioral trends across tens of thousands of bond portfolios. This is the second issue since the quarterly publication launched in October.
The report leverages analysis from State Street Global Markets showing bond flows and holdings indicators from Q4 2018, taken from a data set that represents $10 trillion of assets, which is estimated to account for just over 10% of outstanding fixed income securities globally.
This data showed that institutional investors aren’t rushing to safety, but rather are selling Treasuries. Also, in December at least, institutional investors began to dip a tentative toe back into Italian and emerging market debt.
“This was a surprisingly upbeat set of readings to begin 2019,” the report states.
The data found that — despite record issuance — Treasuries returned their best quarter in three years in the fourth quarter. This is thanks to the risk aversion, softer U.S. economic data and a change in Federal Reserve commentary that happened in the quarter.
“Surprisingly, while the outperformance of Treasuries relative to other markets lifted the value of investor holdings, investors responded by continuing to sell Treasuries across the curve,” the report found.
In contrast to the last big Treasury rally in the first quarter of 2016, investors clearly do not expect the fourth quarter’s gains to be repeated, according to State Street.
State Street also found that total demand for Treasuries was unusually weak.
“There is a bearish interpretation of this, which is that investors are anxious about rising political risk in Treasuries, reflected in the ongoing U.S. government shutdown and rapid rise in issuance,” the report stated.
However, State Street doesn’t think this is the main driver because there would likely be much weaker primary demand from institutional investors if so.
Rather, the report said a more optimistic interpretation would be that investors are concerned that the low in yields seen in December are unlikely to persist into 2019.
Italian and Emerging Market Debt
Outside of the U.S., the two stories that stand out — Italian and local-currency emerging market debt — also involve something of a reversal in sentiment in December that is not fully captured in Q4 behavior.
Demand for these riskier sovereign bonds remained weak in the fourth quarter.
However, State Street also found that “flows into both returned to median levels in December, suggesting risk appetite is getting less, not more, negative.”
Italian bonds — also known as Buoni del Tesoro Poliennali (BTPs) — had a bumpy ride as a budget dispute escalated, but one that ended on a more constructive note. State Street metrics of long-term investor flows, which lean toward international investors, showed a robust improvement for BTPs in December.
“The return of investor sentiment to BTPs has often been fleeting during the past six months, but for now, investors are no longer adding to a defensive BTP position,” the report stated.
Meanwhile, long-term investor holdings of local-currency emerging market debt were at a five-year low. Then, in December, flows jumped above their five-year median for the first time in eight months, according to the report.
“With the chances of a trade truce between the U.S. and China growing and the inflation trend easing quickly, this may be one of the first risky flows to turn more positive once again,” the report stated, also stressing that December’s tentative recovery is not yet a blanket rush back into emerging market debt.
Latin American markets saw the sharpest rebound in flows in December, with Brazil and Mexico in particular experiencing the largest currency recoveries in the past month.
However, currency appreciation did not spur a recovery in demand for South African bonds, while selling of Turkish and Indonesian local-currency bonds also continued, according to State Street.
“The emerging recovery remains selective for now,” the report concluded.
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