Inflation above 6% and long bonds below 2%

Market Development: In November, the Fed unsurprisingly unveiled its tapering programme. Jerome Powell stated that no rate hike will be considered by the FOMC in the short term, but financial markets have already forecast two rate hikes in 2022. The Fed will reduce its monthly purchases by $15 billion/month (10 Treasuries + 5 MBS) as expected, but the reinvestment of proceeds from matured bonds will be done exclusively in Treasuries.

Fund Commentary
16 Dec 2021

Market Development: In November, the Fed unsurprisingly unveiled its tapering programme. Jerome Powell stated that no rate hike will be considered by the FOMC in the short term, but financial markets have already forecast two rate hikes in 2022. The Fed will reduce its monthly purchases by $15 billion/month (10 Treasuries + 5 MBS) as expected, but the reinvestment of proceeds from matured bonds will be done exclusively in Treasuries.

The key event of the month should have been the Federal Open Market Committee (FOMC) and the tapering announcement, but the decision taken by the Bank of England (BoE) was unexpected and took markets by surprise. A rate hike was almost unanimously expected, but the BoE kept its rates unchanged as English central bankers considered the risk of economic slowdown to be greater than the risk of inflation.

Inflation in the US climbed to 6.2%, although the long end of the Treasury yield curve barely moved. The last time inflation reached 6.2% was in September 1990 and the 30y Treasury yield almost hit 9%!

During the month, COVID (the Delta variant) continued to spread in Europe, and fears of new lockdowns increased significantly. This health concern increased after the Thanksgiving Holiday due to the Omicron variant, which could call into question the Year-end rally.

Market Outlook

Our outlook remains focused on the macroeconomic situation (including growth, inflation and unemployment), Central Banks’ behaviour and the evolution of equity markets, which could be more volatile in the coming weeks. The COVID pandemic is still a concern, and the potential danger of the Omicron variant is still unknown.

Inflation fears in the US and Europe are still high, but the scenario of a global slowdown – led by a sharp drop in China’s GDP – is becoming more likely. The economic growth outlook for Q1 2022 – higher commodity prices, the potential damages following the collapse of the Chinese high yield market (led by Property) and the shortage of components affecting different industrial sectors (leading to a possible recession in China), all need to be considered in order to adapt our strategy accordingly.

In the US, long-dated US Treasury yields are decreasing and we continue to look for new entry points to increase the duration of the portfolio, should the opportunity to buy more long bonds on any weakness arise. Fed purchases (still high despite the beginning of tapering) and strong demand for safe-haven assets should stabilise long-term yields at current levels.

A mistake in the Fed’s monetary policy is possible in 2022. Jerome Powell has been confirmed by Biden-Yellen as Fed Chair for a new four-year mandate. His mission will be to fight inflation aggressively in order to stop the escalation before the Mid-Term elections. In Europe, the ECB should stay ultra-accommodative despite higher inflation.

Some high-quality emerging markets could offer investment opportunities, driven by demand, but for the time being, they still appear too risky and uncertain.

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. Hybrid debt is still very expensive: the objective is to keep the existing position for the carry of the spread, but not increase the weight of this asset class until there is a major correction in the equity markets.

High-quality credit spreads are still attractive in the current environment, but our main objective within the next two months is to gradually increase the duration of the portfolio through the purchase of long-dated US Treasuries in order to protect the Strategic Bond Opportunities Fund against the increasing threats mentioned above, which could affect the markets in early 2022.

Portfolio Development

In November, we slightly decreased the weight of BP Hybrid and NextEra 2030 for ESG considerations. We also took the opportunity to add some EDF 2028, a purchase financed by the sale of a US Treasury maturing in May 2022.

 

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 TurbervilleAdam 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 08/12/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.