Desperately seeking inflation


Fund Commentary
21 Sep 2017


Despite some good news from both sides of the Atlantic (strong unemployment figures and retail sales in the US, as well as stronger growth in the Eurozone), inflation was still a concern and potentially a source for nightmares on the part of central bankers in August.

The latter are likely to have shared their views on the topic at the Economic Policy Symposium in Jackson Hole, as CPI figures were still too low: +0.1% MoM and +1.7% YoY in the US and a worrying -0.5% MoM and +1.2% YoY in the Eurozone.

The Fed is still expecting one more rate hike in 2017, but would like to put forward its intention to shrink the size of its large balance sheet. In Europe, Mario Draghi reiterated his message that the ECB will remove its monetary stimulus very slowly.

In addition, the weakness of the dollar is becoming painful for Europe: according to the Investment Adviser, the evolution of the EUR-USD exchange rate (from 1.04 to 1.20) year-to-date has the same impact as one or two rate hikes from the ECB.

In this context:

  • the 2y US Treasury yield hardly moved from 1.35% to 1.33% (-2bps),
  • the 5y decreased from 1.84% to 1.70% (-14bps),
  • the 10y decreased from 2.29% to 2.12% (-17bps),
  • and the 30y declined from 2.90% to 2.73% (-17bps).

In Europe:

  • the 2y German yield decreased from -0.68% to -0.73% (-5bps),
  • the 5y Bund declined from -0.18% to -0.34% (-16bps),
  • and the 10y Bund decreased from 0.54% to 0.36% (-18bps).

On the credit side:

  • the European iTraxx Main barely increased from 52 to 55bps,
  • while the US corporate CDX index started the month at around 57 bps and ended the month at 58bps.
  • In Emerging Markets, the CDX 10y EM index moved slightly from 245 to 242bps (-3bps), supported by an increased allocation, higher growth and lower inflation expectations.


During the month, the Investment Adviser sold the remaining positions in Terna 2018 and Anheuser Busch-Inbev FRN 2018. The team also decreased the weight of the following positions: Daimler 2019, FCE Bank 2019 and RCI 2021. At the same time, the Fund took part in the new issue from Carlsberg (maturity in 2023). The modified duration of the portfolio stayed around 1.1. In terms of portfolio diversification, the Fund held 33 issues from 33 issuers.


During the month, the Investment Adviser decided to sell the three high beta bonds held by the Fund (Viacom hybrid, EDF hybrid and Schaeffler 2023) and to reinvest the proceeds into low beta names, i.e. General Electric 2024 and Pepsi Cola 2026. The modified duration stayed around 5. In terms of portfolio diversification, the Fund held 33 issues from 30 different issuers.


During the month, the Investment Adviser added one new issuer to the portfolio, Enap (Chile, BBB-, government-owned oil & gas company). In terms of geographical breakdown, the top 3 countries were Mexico (14.8%), India (12.3%) and China (9.5%). The rating allocation was 60.5% Investment Grade, 38.4% Crossover (BB+ and BB) and 1.1% cash.

The breakdown of the portfolio in terms of market allocation was 95.3% Emerging Markets, 3.6% Developed Markets (i.e. Luxembourg/ArcelorMittal) and 1.1% cash. In terms of sector allocation, the Investment Adviser favoured Governments (28.8%), followed by Materials (26.3%) and Energy (20.8%). The modified duration increased from 5.3 to 5.5 during the month. In terms of portfolio diversification, the Fund held 37 issues from 36 different issuers.


The Investment Adviser’s outlook remains tied to two major topics, inflation and Central Bank’s behaviour. In Europe and the US, inflation is historically low and is likely to persistently remain below target. The current economic situation in the US is probably at a turning point, at which equities are becoming less attractive and treasuries more interesting.

In Europe, tapering remains the main concern. Should the growth momentum persist and be revised higher, the Investment Adviser may expect the ECB to announce a reduction in the monthly pace of the asset purchases to EUR 40bn for Q1 in 2018, with a potential 6 to 9 month extension. However, further EUR appreciation may slow tapering and push the start of the monetary policy rate normalization forward. In this respect, BBB spreads could widen (both corporate and government) and the Bund curve could potentially steepen further.

As a result, the Investment Adviser is very cautious with regard to the European bond market but still believes that US Treasuries will become more and more attractive as they, especially the long dated ones, could be a top performing asset class in 2018, as an inversion of the slope of the 10-30y yield curve is not excluded. Any correction would be seized by the Investment Adviser as an opportunity to add positions for a medium-long term strategy.

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

In conclusion, the best performing asset class in a short-medium term horizon is still anticipated to be high quality Emerging Markets but in 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 08/09/17 and are based on internal research and modelling.