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deMarket Development: January began with a continuation of the very strong Non-Farm payrolls figures, with the unemployment rate reaching 3.5% and 223,000 job creations. As we have often mentioned, these solid numbers are still far from 150,000, which is a leading indicator of a turning point towards recession.
The inflation figures were encouraging with a negative MoM evolution (-0.1%), but the YoY inflation did not decrease as sharply as expected (6.5% YoY and 5.7% ex-Food & Energy). The Core PCE, which is always a better indicator than CPI regarding the behaviour of the Fed, decreased to 4.4% YoY. This marks a turning point; with a Fed funds rate at 4.5% and Core inflation at 4.4%, the real rate of Fed funds came back to positive territory for the first time since the COVID crisis.
The US yield curve (2-10Yr) stayed inverted and long bond yields decreased significantly. The 2Yr Treasury yield remained volatile, a sign of uncertainties surrounding the behaviour of the Fed over the coming months. We cannot exclude that 3.32%, the level reached by the 10Yr Treasury yield on 19th January, could be the lowest print of the year.
In the credit markets, spreads were well-oriented and credits denominated in US Dollars became expensive, both in absolute and relative terms compared to credit spreads in Euros.
Hybrid bonds rose sharply and new deals in the primary market were massively oversubscribed, an indication of a turning point in the mood of investors towards this asset class. Emerging markets improved slightly, but our decision to avoid the asset class for the time being did not change. The recent events in Peru and Brazil were not encouraging.
January 2023 was an excellent month for global bonds. It was the best January for corporate bonds since 1975. Government bond yields fell and their performance was impressive. As a result, bonds began the year “sur les chapeaux de roues” – but maybe too quick and too far.
Market Outlook
More than ever, we continue following the macroeconomic situation and geopolitical events and conflicts very closely. Inflation is still high, but recession fears have become the main concern.
The behaviour of the Fed towards rate hikes and QT is an issue as many investors, and some FOMC members, believe the Fed is going too quickly and too far.
We do not have any strong conviction on the famous level of pivot rate because we still believe this debate is partially irrelevant as we don’t know the behaviour of the central bank towards the pace of QT; which is at least as important as the level of Fed funds (perhaps more). Should the Fed make an error in its monetary policy, it should come from QT, not rate hikes.
We believe that the US Treasury curve will remain inverted through the 2-10Yr, and more importantly the 5-30Yr. We are prepared to slightly increase the duration of any correction, but the levels reached by long bonds in January were too low.
We also intend to invest in 2Yr TIPS depending on the evolution of the markets in February after the first FOMC of the year (1st February), followed by the ECB meeting.
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 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.
Regarding strategy and portfolio management, we have amended our philosophy slightly in 2023. We call it the 80-20 strategy. 2022 has been an annus horribilis for bonds, with their performance below our worst-case scenarios.
As a result, today, some corporate bonds can deliver a very decent yield. In a high-quality universe, we can assume that default risk is virtually non-existent or non-existent: it means that these bonds will pay the coupon and will be redeemed at par on their maturity date or next call date.
Today, we firmly believe that around 20% of the portfolio is composed of bonds that must be kept in a “buy and hold” strategy. Eventually, their price will converge to 100. It is not “if” but “when”.
We will obviously stay very active in terms of duration and credit spread management with the remaining 80% of the portfolio. Still, we have a strong conviction that this 80-20 strategy is the best behaviour we can adapt with the interests of our shareholders in mind.
Portfolio Development
In January, we did not change our strategy and only sold one security: a corporate bond issued by Roche maturing in 2024, due to a very low spread relative to government bonds.
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 08/02/2023 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.