Markets brace for Trump 2.0

Welcome back to SovereignBeat!

In this publication:

• Cooling job market might push Fed to cut sooner

• Traders bet on Trump-fueled higher US yields

• S&P and Nasdaq smash records again

• Oil prices keep rising amid lower supply

• 28% Haircut for Sri Lankan Debt

Let’s dissect

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Markets Snapshot

Developed Markets

• US: Friday jobs report from the Labor Department, confirmed a deceleration in job growth, with nonfarm payrolls reducing by 12,000 to 206,000, albeit exceeding economists’ consensus forecast for around 190,000.

  Nonfarm payroll measures the number of workers in the U.S. except those who work in farming, private households, non-profits, and sole proprietorships or self-employment, as well as those who are active military service members.

  Despite June's employment growth being marginally stronger than expected, April and May figures were revised downward by a total of 111,000, adding to the recent data indicating a modest slowdown in jobs growth. More importantly, the unemployment rate inched up to 4.1%, corresponding to the highest level since November 2021. The report also showed a decline in annual wage inflation to 3.9%, signaling a further easing in wage pressures.

• The yield of the 10-year U.S. Treasury decreased to 4.28% at Friday’s close, down from 4.37% at the end of the previous week, mainly due to the release of a jobs data report that strengthened expectations of a potential Fed rate cut later this year. Yields of 2- and 30-year notes also declined. The implied probability of at least one rate cut in September increased to 78%, up by 15% from last week. If the Consumer Price Index (CPI) report scheduled to be released this Thursday shows continued stable or lower inflation in June vs May, it will further increase the probability of a rate cut in September.

• The dollar provided one of the earliest indicators of how markets might respond to a potential Trump victory, appreciating in value following debate. While the Federal Reserve's stance on maintaining higher interest rates has supported the USD so far this year, the currency saw a noticeable increase in real-time as Trump outperformed Biden in the debate. In response, investors began purchasing shorter-maturity Treasury notes and selling longer-term ones, engaging in a strategy known as a steepener trade. Traders are now paying the highest price to hedge a selloff in the long-end of the curve since the end of May. This reflects investors' expectations of stronger economic growth and higher inflation, which would lead to higher interest rates. According to Goldman Sachs, if President Trump returns to office, the average US tariff rate could jump by 16 percentage points to nearly 20%, reaching the highest level seen in the postwar era. This spike in tariffs might force the Federal Reserve to raise interest rates five more times than otherwise expected to curb inflation.

Equity Markets

• The S&P 500 and Nasdaq both hit new record highs, with weekly gains of 1.4% and 2.6%, respectively. This marks the tenth positive week for the NASDAQ in the last eleven weeks. The Dow Jones Industrial Average also rose by 0.7%, though it remains 1.6% below its peak from mid-May.

Commodity Markets

• Oil: Brent crude prices rose for the fourth consecutive week, this time by 2% week-over-week to almost USD 87 per barrel, driven by a larger-than-expected decline in US oil inventories and heightened geopolitical tensions in the Middle East. US crude stocks fell by 9.163 million barrels in the previous week, the highest weekly draw since August 2023. We expect tight supplies of crude throughout the summer.

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Global Finance

Sri Lanka Strikes Deals with both OCC and Bondholders

• Sri Lanka has reached an agreement with its bondholders on the terms for restructuring $12 billion in bonds, a significant step towards completing its debt overhaul following a default two years ago. The agreement includes a framework featuring notes linked to economic performance and a governance-linked structure. This agreement aims to restore Sri Lanka's access to international capital markets and facilitate further funding from the IMF after the country defaulted in 2022.

• A little over a week ago, Sri Lanka already finalized a $10 billion restructuring agreement with its Official Creditors Committee (OCC), which includes bilateral lenders and China’s Exim Bank, formalizing provisional agreement previously reached in November 2023. The country signed a memorandum of understanding to restructure $5.8 billion of bilateral debt and reached a final agreement with China’s Exim Bank to restructure $4.2 billion.

• Under the new agreement with the bondholders, new restructured bonds will have a 28% haircut under the IMF's nominal GDP growth scenario and an 11% haircut for the total Past Due Interest (PDI) capitalized under a new vanilla bond. MLB bonds will consider both nominal GDP in USD and a government control variable that triggers adjustments to the coupon rate and nominal haircut if cumulative real GDP growth exceeds 11.1%. The agreement terms must align with those agreed upon with the Official Creditor Committee to ensure comparability of treatment and meet the IMF’s debt sustainability objectives for Sri Lanka's IMF-supported program. Therefore, both the OCC and IMF are expected to confirm comparability before proceeding with finalization.

Our thoughts:

• Looks like they found a compromise after initial March terms, in which bondholders advocated for a single test for MLB bonds based on Sri Lanka’s average nominal GDP in USD. By incorporating real GDP performance as a second variable, Sri Lanka’s probably seeks to prevent a scenario where an appreciated rupee alone forces higher repayments to bondholders, especially if the appreciation is in practice caused by a weaker economy. Also, relying solely on nominal GDP criteria would make it more likely for the bonds to be index-eligible, resulting in greater upside for the price, but would also raise the risk of higher debt repayments. We will see how the IMF and OCC respond to this proposal.

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