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deMarket Development: October began with the unemployment rate reaching 3.5%, a record low. With more than 250,000 job creations, the labour market doesn’t show any sign of recession.
In addition, the unveiling of inflation figures; CPI at 8.2% but Core CPI at 6.6%, the highest level seen since September 1982, led the markets to forecast a 75bp rate hike on 2nd November. Record low unemployment and simultaneous record high core inflation mean that the ultra-hawkish monetary policy of the Fed will likely continue.
Only a few market participants, led by Charles Evans (Fed of Chicago) warned the central bank regarding the risks of moving too far and too fast in terms of adjustments to monetary policies; noting that a PCE Deflator at 6.2% and Core PCE at 5.1% show less alarming figures than the CPI.
If we consider that the most relevant inflation rate is the Core PCE (5.1%), if the Fed raises its Fed funds to 4% on 2nd November; and if we add another virtual 1% due to the impact of the Quantitative Tightening policy, the real Fed funds rate is not in negative territory anymore.
In Europe, following the unbelievably forced technical QE by the BoE to rescue a collapsing market in the UK, all eyes turned to the ECB. As anticipated, Mrs Lagarde announced a 75bp rate hike, but despite a Refi rate reaching 2% and a deposit rate at 1.5%, the ECB is still behind the curve.
Market Outlook
More than ever, we continue to follow the macroeconomic situation and geopolitical events and conflicts very closely. Inflation remains very high and growth has turned negative.
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 a concern as many investors, and some FOMC members, believe the Fed is going too quick and too far.
We do not have any strong conviction on the famous level of pivot rate, as we still believe this debate is partially irrelevant, as we do not know the behaviour of the central bank towards the pace of Quantitative Tightening; which is at least as important as the level of Fed funds (perhaps more).
Should the Fed remain reluctant to be clear on the combined effect of rate hikes and QT, a Quantitative Easing program is more likely than a series of rate cuts in a 9-12 month horizon.
We believe that the US Treasury curve will remain inverted, through the 2-10Yr and, more importantly, the 5-30Yr. We are prepared to increase the duration slightly before year-end if necessary.
We will probably continue to invest in high quality-low duration credits, depending on the behaviour of Investment grade spreads, which are highly correlated to the evolution of equity markets. At this stage, reinvesting in Emerging Markets seems unlikely in the near-medium 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 hybrid debt (both in EUR and USD). We are also considering increasing the duration slightly, depending on market evolution and central banks’ behaviour.
Portfolio Development
In October, we did not change our strategy and took the opportunity to increase the duration of the Strategic Bond Opportunity Fund slightly, with the purchase of a US Treasury maturing in 2027 and the sale of a US Treasury maturing in 2023 (switching from 1Yr in favour of 5Yr).
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.
Adam Turberville
Director
+44 1481 742380
a.turberville@ericsturdza.com
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The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 11/11/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.