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deMarket Development: In September, three major central banks: the Fed; the ECB and the SNB; raised their key rates by 75bp. In June, Jay Powell said that this was “exceptional” compared to more traditional rate hikes of 25 or 50bp. Apparently, 75bp has become the new normal to fight aggressively against inflation, which hasn’t decreased as fast as anticipated.
The CPI YoY decreased from 8.5% to 8.3%, higher than the 8.1% expected by the markets. Excluding food and energy, the CPI reached 6.3%, against the 6.1% forecasted by the markets.
In addition, the PCE Deflator and the PCE Core (which are the favourite indicators of the Fed) also decreased, but again, not as much as anticipated: to 6.2% (6% expected) and 4.9% (4.7% expected) respectively.
Following the Fed’s rate hike to 3.25% (upper bound), if we assume another 75bp hike on 04th November; and if we add another “virtual” 1% due to the impact of Quantitative Tightening; real Fed funds will now turn positive before the last FOMC on 14th December: 4% + 1% – 4.9% (i.e. PCE Core) = +0.1%.
Is the Fed close to the end of its rate hike cycle? This will be the main (if not only) topic of the last quarter of 2022.
Market Outlook
More than ever, we continue to follow the macroeconomic situation and geopolitical events and conflicts very closely. Inflation is still very high and growth has turned negative.
Recession is coming rapidly, 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 a concern as many investors, and some FOMC members, believe the Fed is going too quick and too far. Market participants are already forecasting a first-rate cut in H2 2023.
We have no opinion on this major topic as we still don’t know the central bank’s behaviour towards the pace of Quantitative Tightening, which is at least as important as the level of Fed funds. Should the Fed remain reluctant to be clear on the combined effect of rate hikes and QT, a Quantitative Easing program will be more likely than a series of rate cuts in a 9-12 month horizon.
In the US, we believe that the Treasury curve will remain inverted, through the 2-10Yr, more importantly, the 5-30Yr. We are prepared to increase the duration slightly in Q4 2022. We will probably continue to invest in high quality-low duration credits, depending on the behaviour of Investment grade spreads, which are highly correlated to the evolution of equity markets. At this stage, reinvesting in Emerging Markets seems unlikely in the near-medium 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 the central bank’s behaviour.
Portfolio Development
In September, we did not change our strategy and took the opportunity to buy a US Treasury maturing in March 2024 yielding 4.39%.
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.
Adam Turberville
Director
+44 1481 742380
a.turberville@ericsturdza.com
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The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 10/10/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.