Market Development: Despite the release of encouraging US employment and inflation figures during the month, the Fed has not yet won its battle against inflation, as recent data indicates it is still well above its 2% target.
Statements made by the Fed Chairman, Jerome Powell, at the Jackson Hole symposium confirmed the Fed’s willingness to make monetary policy more restrictive, even if it means sacrificing employment. Thus, further rate hikes are expected between now and December.
These, combined with an accelerated balance sheet reduction program, from a monthly $47.5bn to $95bn in September, could lead the economy to slow down sooner than expected, increasing the risk of recession.
Against this backdrop, the US 10Yr yield, which stood at 2.65% at the end of July, has risen above 3%, with the 2-10Yr yield curve remaining inverted. Even if it is difficult to know whether long-term rates have peaked, market volatility will persist unless inflationary pressures are brought under control.
In Europe, with inflation remaining stubbornly high, the ECB has no other option but to pursue its rate hike cycle in the wake of the Fed. Recent ECB comments following the release of the inflation figures have pushed up the short end of the curve, triggering the underperformance of the EUR fixed income markets over the month.
With significant rate hikes expected to combat rising inflation, fears of gas supply cuts this winter, and macro indicators pointing to a growth contraction by the end of the year, the ECB will, at some stage, have to reassess the pace and scope of its monetary policy normalisation.
In August, we slightly decreased the Strategic Bond Opportunities Fund’s duration by switching our remaining exposure in a 30Yr Treasury into a 20Yr Treasury, judging the positive differential attractiveness (>20bp). We have maintained the exposure in the Investment Grade sub-portfolio for now, based on its average high quality and carry diversification.
More than ever, we will continue to follow the macroeconomic situation, geopolitical events and conflicts very closely. Inflation remains very high despite the first decrease in July (8.5% in the US, after 9.1% in June), but growth has turned negative rapidly. A recession is coming and the excellent behaviour of the labour market is, against all odds, a leading indicator of an imminent decline of the economy.
The behaviour of the Fed towards rate hikes and Quantitative Tightening is becoming less predictable, as the US central bank will abandon forward guidance and become data-dependent. Market participants are already forecasting a first-rate cut in H2 2023.
In the US, we believe that the Treasury curve will continue to inverse, through the 2-10Yr initially, then through the 5-30Yr. We are prepared to increase the duration slightly in H2 2022 and the first step will be to abandon our duration overlay policy (short position on 10Yr note futures).
We will probably continue to invest in high quality-low duration credits, with reinvesting in Emerging Markets seeming an unlikely option in the near term.
As a result, we believe that the best strategy today is to invest in a selection of high-quality corporate bonds, both in EUR and USD, favouring USD Investment Grade and keeping hybrid debt (both in EUR and USD). We are also considering increasing the duration slightly, depending on market evolution and central banks’ behaviour.
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 13/09/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.