Draghi’s bazooka is stronger than Grexit fears


20 Apr 2015


In March, the European economy continued to show signs of improvement while US economic statistics disappointed despite very good unemployment figures. In Europe, if the recovery seems on track with higher levels of business confidence it must still be confirmed.

The European Central bank (ECB) started its sovereign debt purchasing program on 9 March, buying debt from five major countries: Germany, France, Italy, Spain and Belgium; therefore pushing 10y Italian and Spanish yields to record lows at 1.13% and 1.14% respectively despite the growing risk of another Greek crisis. In the US, unemployment figures were very strong, adding 295’000 jobs leading to a drop in the unemployment rate to 5.5%. These encouraging figures were not confirmed by wage growth which remained sluggish. Other data such as retail sales, housing starts and manufacturing activity decreased sharply. In the meantime, the price of WTI crude oil fell to USD 44 per barrel which is the lowest price in six years. The Federal Reserve (Fed) opened the door to a first rate increase in June but, at the same time, confirmed that inflation and wage growth remain too low for them to raise rates in the near future. More importantly, it confirmed that the pace of rate increases will be very slow. Consequently, the median forecast for Fed Fund rates in December 2015 decreased to 0.625%. The Investment Adviser believes that the Fed will stay very pragmatic and could postpone its first rate hike to Q3, Q4 2015 or even early 2016. It seems that, once they removed the word “patient” from their statement, US Central bankers have become more patient than even before!

The German government yield curve experienced a bullish flattening this month, the 2y yield decreasing from -0.23% to -0.25% (-2 bps), the 5y from -0.09% to -0.10% (-1 bp) and the 10y from 0.33% to 0.18% (-15 bps). On the credit side, both US corporate CDX & European iTraxx main indexes widened slightly: the CDX moved from 61 to 64 bps and the ITraxx from 50 to 56.

Assets did not move significantly during the month. The Fund took part in the Edenred exchange offer (purchase of the new 10y issue against the tender of the 2017 one), reduced Nederlandse Gasunie 2017 and decreased the weight of Cnooc in order to reduce China in the country allocation and Oil & Gas in the sector allocation. At month end, the Fund held 51 issues and 50 issuers.

 The duration overlay policy was stable in March. Corporate bond trades slightly decreased the modified duration of the portfolio from 6.1 to 6.0 and the modified duration of the Fund decreased from 2.8 to 2.7.

With the ECB starting its own QE and continuing to be active in the global currency war, the deflationary potential effects are increasing on both sides of the Atlantic and should maintain demand for yield. The first ECB QE is already supporting European economies and if this does not take place, additional measures will certainly be taken. Depending on market reactions, the Investment Adviser may maintain the duration risk of the Fund above 2.5 and below a maximum of 3. On the credit side, ECB QE will underpin high grade corporate bonds. The bond selection will be driven by opportunities in both primary and secondary markets. As a consequence, positive returns will still be achievable as a result of the carry of corporates, their spread tightening potential, credit selection and active management of duration and yield curve.

The views and statements contained herein are those of Banque Eric Sturdza in their capacity as Investment Adviser to the Fund as of 15/04/15.