Market Development: In early July, the publication of the last FOMC minutes confirmed the Fed’s intention to implement a new series of rate hikes to combat inflation aggressively. The excellent Non-Farm Payroll figures encouraged the central bank to opt for a 75bps hike on 27th July.
Other similar decisions are likely, and the acceleration of the Quantitative Tightening program is scheduled for the coming weeks. In this context, the US 10Yr Treasury yield, which reached 3.25% at the end of June, decreased to close to 2.80% at the end of July. At the same time, a more pronounced inversion of the 2Yr to 10Yr slope of the curve revealed the high level of recession fears in the fixed-income markets.
In Europe, the ECB increased its key rates by 50bps on 21st July, despite a political crisis in Italy leading to the resignation of Mario Draghi. The widening of peripheral spreads, particularly in Italy, was a concern for the ECB and the central bank unveiled a new anti-fragmentation tool in order to maintain spreads at decent levels. Even if Ms Lagarde did not disclose the details of this tool, called the Transmission Protection Instrument (TPI), this decision was a relief for BTP holders.
Both central banks, the ECB and the Fed decided to abandon the concept of forward guidance, which was replaced by the concept of data dependency.
Our outlook continues to focus on the macroeconomic situation. Inflation remains very high (9.1% in the US), but growth has turned negative. A recession is coming rapidly and the excellent behaviour of the labour market is, against all odds, a leading indicator of an imminent decline of the economy.
The behaviour of the Fed towards rate hikes and Quantitative Tightening is becoming less predictable as the US central bank could abandon forward guidance and become data-dependent. Market participants are already forecasting a first-rate cut in H2 2023.
In the US, we believe that the Treasury curve will continue to invert, through the 2-10Yr initially, then through the 5-30Yr. We are prepared to slightly increase the duration in the coming weeks following the first step in July when we abandoned our duration overlay policy (short position in 10Yr Treasury note futures). We will probably continue to invest in high-quality low duration credits, but reinvesting in Emerging Markets seems unlikely in the near term.
As a result, we believe that the best strategy today is to invest in a selection of high-quality corporate bonds, both in EUR and USD, favouring USD Investment Grade and keeping (but not increasing) hybrid debt, both in EUR and USD. We are also considering increasing the duration slightly, depending on market evolution and central banks’ behaviour.
In July, we increased the duration of the Strategic Bond Opportunity Fund with the sale of our remaining short position in 10Yr Note Futures. As a result, our duration overlay policy has been suspended until further notice.
In the Investment Grade sub-portfolio, we sold our position in Italy 2029 when Mario Draghi resigned in order to prevent any further spread widening. We also sold our position in Nestlé 2028 due to its very tight spread.
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 08/08/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.