Currency wars become a yield war


Fund Commentary
23 Mar 2015


In February, Central bank stimulus and deflation fears led to record-low yields. As the currency war continued, many Central banks stayed very active and year-to-date, more than 20 countries saw their key rate decrease, including Canada, Australia, China, India, Thailand, Turkey, Denmark, Indonesia and Switzerland. In Europe, the European Central Bank (ECB) started to give more details on the EUR 1.1 trillion QE program.

The major event was probably Greek banks being cut-off from regular ECB funding, sign of the deep disagreement between Greece and its European partners and creditors. The European economy showed signs of improvement as German growth reached +0.7% in Q4 2014 and Spain saw the first annual growth in 2014 (+1.4%) since seven years. This could be the first step of better behaviour for European growth, helped by a miraculous alignment of four planets: low euro, low oil prices, low interest rates and the ECB’s QE. This is encouraging but, on the other hand, if growth does not increase with all these boosters, it will never do so. In the US, unemployment figures were strong but wage growth stayed sluggish. This is one of the major reasons why the Federal Reserve (Fed) kept a “patient” stance. Mrs Yellen said during her testimony at the Congress, that inflation and wage growth remain too low for the Fed to raise rates. She announced that the forward guidance will be changed before any rate hike. In other words, the markets expect that the word “patient” will be removed at the next FOMC meeting, opening the door to a first (and only?) hike in June.

The US government yield curve experienced an important steepening. The 2y US Treasury yield increased from 0.45% to 0.62% (+17 bps), the 5y from 1.16% to 1.50% (+34 bps), the 10y from 1.64% to 1.99% (+35 bps) whilst the 30y increased from 2.22% to 2.59% (+37 bps). As a consequence, the 5-30y spread (strategy implemented in the Fund at 151 bps) widened slightly from 106 to 109 bps.  On the credit side, both US corporate CDX & European iTraxx main indexes performed well due to Central bank stimulus and concerns about deflation. The CDX moved from 70 to 61 bps and the ITraxx tightened form 60 to 50.

Assets did not move significantly, during the month. The Investment Adviser decreased the weight of Chinese and Hong Kong issuers, including China Uranium 2018, Sinopec 2018, Cnooc 2022 and Hutchison Whampoa 2022 (as its management is becoming too aggressive in the European telecom sector M&A activity). The proceeds were reinvested in Roche 2024 and US Treasuries 2024, 2025 and 2044. Most of these purchases were partially hedged by increasing the short position in the 5y T-note future.

At month end, the Fund held 46 issues and 40 issuers. 

The duration overlay policy has been reintroduced as the Investment Adviser wanted to adopt a more cautious stance while trading activity in the portfolio increased its modified duration from 6 to 6.2. A short position in 5y T-notes futures has been reinitiated in order to decrease the overall modified duration of the Fund from 6 to 5.4 and to partially hedge the 10-30y investments by a short 5y position (bullish flattening strategy). 

With the ECB joining the global currency war, the deflationary potential effects are increasing on both sides of the Atlantic and should maintain demand for yields. US economic forecasts are still expected to be contradictory; sustained growth and labor market vs falling inflation. The Investment Adviser will maintain the duration risk of the Fund at around 5 during March, as weaker global growth, monetary easing and disinflation are supportive of duration and flattening of the yield curve. On the credit side, corporate bond selection will be driven by valuation opportunities in both primary and secondary markets. As a consequence, positive returns will be achievable as a result of the carry of corporates, their spread tightening potential, credit selection but, first and foremost in 2015, active management of duration and yield curve.

The views and statements contained herein are those of Banque Eric Sturdza in their capacity as Investment Advisers to the Fund as of 18/03/15 and are based on internal research and modelling.