Market Development: On 4th May, the Fed increased its fund rates by 50bp, but due to the Quantitative Tightening program unveiled the same day ($47.5 billion in June, July and September, increased to $95 billion / month after September), we consider this decision to be similar to a 75bp rate hike. Another series of 50bp hikes on 15th June and 27th July are almost certain.
The Fed’s strategy to combat inflation will be applied in two phases: from accommodative to neutral; and from neutral to restrictive. The neutral level should be reached after another 25bp rate hike on 21st September.
Following a good set of job data, the markets were disappointed by the CPI: inflation is slowing down, but not as quickly as expected. Retail sales were encouraging, but unfortunately driven by the inflation component – in “real” terms, they were close to neutral.
Our outlook will focus on the behaviour of the Fed and the ECB. They will be key drivers in the evolution of the markets. In the current environment, growth should decline and inflation will probably increase slightly, or stabilise at very high levels.
As a result, now more than ever, we will continue to focus on the macroeconomic situation (including growth, inflation and unemployment), central banks’ behaviour and the evolution of equity markets. The main message given by the markets is that the fixed-income bear market is not over, but we could rapidly reach a level that could become a good entry point.
A monetary policy mistake made by a major central bank, such as the Fed or the ECB, due to a too aggressive tightening, is looking more and more likely. We believe the Fed knows the problem and will make a mistake intentionally.
This is not traditional inflation and rate hikes will not be very useful. They will kill inflation, but indirectly as they will lead to recession and inflation will eventually decrease sharply because of that recession.
An aggressive Quantitative Tightening policy combined with a series of rate hikes seems inappropriate. The issue is that central banks have no choice but this one. The Fed mentioned that the second phase of its strategy (from neutral to restrictive) would start after September. The Mid-Terms will be in November. These two events combined will probably lead to a recession after November.
In the US, long-dated US Treasury yields will probably continue to suffer in the short term but could become more attractive should they reach key levels around 3.20%-3.30%. We will avoid high beta credit risk in general and we do not intend to invest in Emerging Markets in this uncertain environment.
In terms of portfolio management for the coming weeks, we will continue to follow our strategy but avoid tactical short-term positions. Should the 30Yr Treasury yield continue to climb, we will increase our position in order to protect our credit portfolio with this natural hedge.
Depending on the behaviour of 10Yr Treasury yields, we could consider decreasing our duration overlay policy. Should the Fed make a policy mistake, the sweet spot on the US Treasury yield curve could be the 5Yr, which we purchased in May.
As a result, we believe that the best strategy today is to avoid portfolio turnover and keep our investments in a selection of high-quality corporate bonds, both in EUR and USD. Hybrid debt has suffered recently, but they are becoming a buying opportunity, which has become more attractive than in March 2020 during the worst period of the COVID pandemic.
High-quality credits are probably the sweet spot and we will keep our existing position due to the generous carry of the spreads. Now more than ever, active management of the four pillars of our strategy is key to protecting our portfolio in the short-term bear market and delivering a robust performance in the medium and long term.
In May, we increased the duration of the Strategic Bond Opportunity Fund in two steps. Firstly, we sold some short-term Treasuries maturing in March 2023 and bought some December 2026 Treasuries, the cheapest point on the 3-6Yr curve. We also substantially decreased our short position in 10Yr Note Futures.
In the Investment Grade sub-portfolio, we sold KDB and slightly reduced the weight of Verizon, AstraZeneca, Deutsche Telekom, Orange and Export-Import Bank of Korea.
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.
+44 1481 742380
The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 07/06/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.