Poor liquidity, Greece and signs of recovery push Bund’s volatility to record high


23 Jun 2015


In May, US economic statistics recovered with manufacturing activity, leading indicators and employment figures pointing up, while existing home sales fell and the trade deficit widened. The latest Fed minutes confirmed that the US Central Bank expects GDP growth to pick up after disappointingly weak performance in Q1. Moreover, some Fed members’ comments suggest that eventual monetary policy normalisation has been postponed to the end of the year.

In Europe, strengthening economic signs (industrial production, private sector lending and domestic demand) and the European Commission upgrading its 2015 growth forecast from 1.3% to 1.5%, have reduced the risk of a serious deflation in the coming months. However, inflation is still short of the ECB’s 2% target and will dampen any idea of the ECB’s Quantitative Easing tapering before its expected maturity (September 2016). During the month, the ECB reached its EUR 60bn QE monthly target and announced that it is preparing to front-load bond purchases in June, to avert lower summer market liquidity. Furthermore, Greece has avoided defaulting but remains under heavy pressure, as negotiations between government representatives and its creditors prove fruitless. The Greek drama has started to push periphery countries spreads wider. In this context, government bond market volatility has also increased given reduced deflation concerns and better growth expectations in Europe but also due to technical factors (thin market liquidity, weak market depth in Futures). 

The German government yield curve experienced a bearish steepening this month: the 2y and 5yr yields stayed barely unchanged at respectively -0.23% and 0% and the 10y increased from 0.37% to 0.49% (+12 bps) with a high on 13 May  at 0.74%. On the credit side, the rising government bond yields had a minimum impact on average credit spreads. Indeed, the US corporate CDX index remained unchanged at 64 bps while the European iTraxx Main widened slightly from 61 to 66.

In this context, the Investment Adviser participated in four new issues given higher term premium: Adecco 2022, General Electric Company 2023, Unilever 2023 and Tennet Holding 2021. These positions were mainly financed by the sale of the remaining positions in Adecco 2018, Nederlandse Gasunie 2017 and by reducing positions in BMW 2025 and Roche 2025.  The Investment Adviser also decided to sell the remaining position in America Movil given its tight spread. Consequently, exposure to Mexico was reduced to 0% and the weight of Telecom from 7.8% to 5.6%. At month end, the Fund held 52 issues and 51 issuers. 

The duration overlay policy was stable in May. The portfolio’s modified duration stayed at 6.1 and the modified duration of the Fund slightly increased from 2.72 to 2.74.
The Investment Adviser believes that the ECB, which started its own QE in March, will continue to be active in the global currency war and tolerate bond yield volatility until a certain point. This first ECB QE has been well implemented but European economies remain fragile to financial conditions and the QE may run longer than anticipated if needs be. Depending on market reactions, the Investment Adviser may maintain the duration risk of the Fund above 2.5 and below a maximum of 3. As previously mentioned, peripheral spreads will not be considered as a buying opportunity as long as the Investment Adviser is concerned about a possible Greek default. On the credit side, the European QE will underpin high grade corporate bonds. The bond selection will be driven by opportunities in both primary and secondary markets and 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 Sturdza Private Banking Group in their capacity as Investment Adviser to the Fund as of 15/06/15.