Central banks behaviour will be led by inflation, not growth


Fund Commentary
25 Jan 2018


In December, US economic data were mixed, with a very strong housing sector and unemployment figures on the one hand, and lower consumer confidence (with the University of Michigan Consumer Sentiment Index decreasing from 98.5 to 95.9) on the other hand. Inflation is still stable as wage growth remains subdued (+2.5% YoY 2017), despite a very low unemployment rate (4.1%). The CPI increased by +0.4% MoM in November, with the core CPI (ex-food & energy) however only rising by +0.1%. As a result, the YoY core CPI still remains below 2% (+1.7%).

In December, the major driver for the US markets was the tax reform, finally signed into law by President Trump. In Europe, German economic data were disappointing, led by a lower IFO business climate index, potentially caused by the difficulties encountered by Chancellor Merkel to build a coalition government.

Throughout the month, Central Banks did not change their policies. However, the name of the Fed’s new chairman was finally unveiled: Jerome Powell will replace Janet Yellen in February this year. Moreover, the Federal Open Market Committee (FOMC) voted 7-2 in favour of another 25 bps rate hike. The number of hikes projected for 2018 however remained unchanged.

In Europe, the ECB left rates unaltered and confirmed that monthly asset purchases will decrease from EUR 60 to EUR 30 billion per month between January and September 2018. The ECB revised up its growth forecasts for the next three years up, but at the same time confirmed that inflation will stay below the 2% target.

In this context, the US curve has continued to flatten:

  • the 2y US Treasury yield increased from 1.78% to 1.88% (+10bps),
  • the 5y rose from 2.14% to 2.21% (+7bps),
  • the 10y stayed at 2.41% (flat),
  • and the 30y decreased from 2.83% to 2.74% (-9bps).

In Europe, German yields increased, led by the 5y Obl:

  • the 2y German yield increased from -0.68% to -0.63% (+5bps),
  • the 5y rose from -0.31% to -0.20% (+11bps),
  • and the 10y Bund increased from 0.37% to 0.43% (+6bps).

On the credit side:

  • the European iTraxx Main marginally decreased from 48 to 45bps,
  • while the US corporate CDX index also marginally declined from 52 to 49bps.

In Emerging Markets:

  • the CDX 10y EM index plummeted from 238 to 196bps (-42bps).


During the month, the Investment Adviser decreased the weight of the following holdings: Würth 2018, Honda FRN 2019, Coca Cola FRN 2019, Daimler 2019, Schlumberger 2019, Eni 2020, Enexis 2020, TenneT 2020, Total FRN 2020, RCI Banque 2021, Telekom Austria 2021, and Carlsberg 2023. Moreover, the remaining stakes in FCE bank 2019 were sold. On the buy side, one new name was purchased: EDP (Portuguese Electric Company) 2025, which has been recently upgraded from BB+ to BBB by Standard and Poor’s. The bond was bought at 1.03% (Bund + 107bps). With regard to the Future market, the Investment Adviser reduced the short position by buying back 15 Bunds. As a result, the modified duration increased from 1.6 to 1.9. In terms of portfolio diversification, the Fund held 33 issues from 33 issuers.


he Investment Adviser decreased the weight of Merck 2019 and bought two new names: Pernod-Ricard 2022 (France, Beverages, Baa2/BBB) and Tencent 2020 (China, Internet, A2/A+). The modified duration decreased from 5.7 to 5.4. In terms of portfolio diversification, the Fund held 29 issues from 27 different issuers.


During the month, the Investment Adviser decreased the weight of Cnooc 2021, Anglogold 2022, China Development Bank 2022, Development Bank of Kazakhstan 2022, Export-Import Bank of India 2023, Romania 2024, Bhari Airtel 2024 and Mexico 2027. The team sold the remaining stakes in Cofide 2019, Lithuania 2020 and Latvia 2021. At the same time, the Investment Adviser bought the new republic of Indonesia 2048. In terms of geographical breakdown, the top 3 countries were Mexico (15.9%), India (11.8%) and China (11.2%). The rating allocation was 60.0% Investment Grade, 34.3% Crossover (BB+ and BB) and 5.7% cash. The breakdown of the portfolio in terms of market allocation was 90.1% Emerging Markets and 4.3% Developed Markets (i.e. Luxembourg/ArcelorMittal).In terms of sector allocation, the Investment Adviser favoured Materials (30.3%) followed by Energy (20.9%) and Government (19.2%). The modified duration stayed around 5.2-5.5 during the month (5.3 at month end). In terms of portfolio diversification, the Fund held 34 issues from 34 issuers.


The Investment Adviser’s outlook remains tied to two major topics, inflation and Central Banks’ behaviour. In Europe and the US, inflation is historically low and is likely to remain persistently below target. The current economic situation in the US is probably at a turning point, at which equities are becoming less attractive and long Treasuries more interesting despite increasing volatility due to lower levels of Quantitative Easing.

In the US, the Investment Adviser still believes that long US Treasuries (10 to 30 years) will become increasingly attractive. The team thinks that they could be a top performing asset class in 2018, with an inverted slope of the curve not being excluded. Any correction would be seized by the Investment Adviser as an opportunity to add positions for a medium-long term strategy (outright and/or purchase of 30y bonds hedged by a short 5y future position).

In Europe, tapering remains the main concern. After the October ECB meeting, the picture is clearer and the ultra-accommodative policy likely to persist. As a result, the team is more comfortable with BBB spreads as both corporates and peripheral governments could still widen but not to the degree expected. Regarding the Bund curve, the potential steepening seems postponed to a latter point in time as the European Central Bank is still very dovish.

The Investment Adviser will continue to closely monitor the resilience of the global cyclical recovery, G3 Central Bank balance sheets, tapering concerns and geopolitical risks in order to seize any opportunity to reinvest in high beta Emerging markets. The team thinks that the latter still offer the best risk-reward profile and continue to be supported by low defaults, attractive carry and low supply.

In conclusion, the Investment Adviser perceives the best performing asset class in a short-medium term horizon to be high quality Emerging Markets, but from a medium term perspective (2018 and beyond) long dated US Treasuries look appealing.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 10/01/18 and are based on internal research and modelling.