Market Development: In March, the news was dominated by the evolution of the war in Ukraine. High inflation, coupled with low unemployment rates, has convinced the Fed to start its series of rate hikes, with the first step of 25bp on 16th March. The dot plots and Jay Powell’s speeches were consistent with the Fed fund rates; around 2% at the end of the year.
The Fed has also begun to communicate its intention to shrink the size of its balance sheet. This very hawkish behaviour led the bond market to consider the first-rate cut at the end of 2023.
In this challenging environment, the US yield curve climbed significantly. At the same time, Investment Grade spreads widened sharply, opening the door for investment opportunities. The only asset class delivering positive returns in March was the Euro hybrid corporate market.
Our outlook will focus on the behaviour of the Fed and the ECB. They will likely be a key driver in the evolution of the markets and apparently, their behaviour will not change due to the evolution of the war in Ukraine. In the current environment, growth will decline and inflation will continue to increase sharply.
As a result, now more than ever, we will continue to focus on the macroeconomic situation (including growth, inflation and unemployment), Central Banks’ behaviour and the evolution of equity markets.
The main message given by the markets is that the fixed income bear market is not over, but we could rapidly reach good entry point levels. A monetary policy mistake made by a major central bank such as the Fed or the ECB due to overly aggressive tightening is looking more and more likely.
An aggressive Quantitative Tightening policy combined with a series of rate hikes is not an option in our view, but it is likely that the Fed will seriously consider this possibility.
In the US, long-dated US Treasury yields should continue to suffer in the short term but could become more attractive should they reach key levels around 2.9%-3.0%. We will avoid high beta credit risk in general, and Emerging Markets in particular in this uncertain environment.
In terms of portfolio management for the coming weeks, we will continue to follow our strategy; but we will avoid tactical short-term bets. Should the 30y Treasury yield continue to climb, we would increase our position in order to protect our credit portfolio with this natural hedge.
Depending on the behaviour of 10y Treasury yields, we could consider a decrease in our duration overlay policy. Should the Fed make a policy mistake, the sweet spot on the US Treasury yield curve could be the 5y, which has been hammered recently.
As a result, we believe that the best strategy today is to keep our investments in a selection of high-quality corporate bonds, both in EUR and USD. Hybrid debt has suffered recently, but their March must be confirmed. High-quality credits are at risk, but we will retain our existing position due to the generous carry of the spreads.
More than ever, active management of the four pillars of our strategy is key to protecting our portfolio in the short-term bear market, and to delivering a robust performance in the medium and long term.
Following a very intense January with the large decrease of Hybrids and Emerging Markets, and a less active February, we decided to amend our strategy significantly in March through the weights of our “four pillars”. Firstly, we removed exposure to Emerging Markets with the sale of our remaining positions in Baidu, Tencent, Mamoura (ex-Mubadala) and Enel Americas.
We also slightly reduced some positions which had weights close to 4% of the portfolio. In the Investment Grade markets, this concerned EDF 2028, Deutsche Telekom 2030, Orange 2031 and NextEra 2030. In the hybrid bonds pillar, this concerned Veolia and Iberdrola.
In order to decrease the duration of the Strategic Bond Opportunities Fund sharply (close to 2.7 at month-end), we sold the majority of our position in 30y US treasuries and we dramatically increased the short position in 10y-Note futures. The proceeds of all these sales have been reinvested in short term Treasuries maturing in May and July 2023.
As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact us for further information.
+44 1481 742380
The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 08/04/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.