QE and the alignment of planets


Fund Commentary
23 Mar 2015


In February, Central bank stimulus and deflation fears led to record-low yields. As the currency war continued, many Central banks stayed very active and year-to-date, more than 20 countries saw their key rate decrease, including Canada, Australia, China, India, Thailand, Turkey, Denmark, Indonesia and Switzerland.

In Europe, the European Central Bank (ECB) started to give more details on the EUR 1.1 trillion QE program. The major event was probably Greek banks being cut-off from regular ECB funding, a sign of the deep disagreement between Greece and its European partners and creditors. The European economy showed signs of improvement as German growth reached +0.7% in Q4 2014 and Spain saw the first annual growth in 2014 (+1.4%) since seven years. This could be the first step of better behaviour for European growth, helped by a miraculous alignment of four planets: low euro, low oil prices, low interest rates and the ECB’s QE. This is encouraging but on the other hand, if growth does not increase with all these boosters, it never will. In the US, unemployment figures were strong but wage growth stayed sluggish. This is one of the major reasons why the Federal Reserve (Fed) kept a “patient” stance. Mrs Yellen said during her testimony at the Congress, that inflation and wage growth remain too low for the Fed to raise rates. She announced that the forward guidance will be changed before any rate hike. In other words, the markets expect that the word “patient” will be removed at the next FOMC meeting, opening the door to a first (and only?) hike in June.

The German government yield curve steepened during the month, the 2y yield decreasing from -0.19% to -0.23% (-4bp), the 5y from -0.05% to -0.09% (-4bp) and the 10y increasing from 0.30% to 0.33% (+3bp). On the credit side, both the US corporate CDX & European iTraxx main indexes performed well due to Central bank stimulus and concerns about deflation. The CDX moved from 70 to 61 bps and the ITraxx tightened form 60 to 50.

Assets further increased during the month from EUR 116.2 to 120.8 million. The Fund took part in four new deals in the primary market, Nordea Bank 2025 (first purchase of a bank since August 2011), Roche 2025, Mondelez 2022 and Coca Cola 2023. The exposure to the French BBB Wendel was increased and Wolters Kluwer 2018 was switched against the 2023 benchmark issue. Finally, Hutchison Whampoa was decreased as its management is becoming too aggressive in the European telecom sector M&A activity. At month end, the Fund held 51 issues and 50 issuers. 

The duration overlay policy was stable in February. Corporate bond trades slightly increased the modified duration of the portfolio from 5.8 to 6.1 and as the Investment Advisor did not hedge these purchases, the modified duration of the Fund increased from 2.5 to 2.8 in order to benefit from the European bull market before the first wave of purchases by the ECB.

With the ECB joining the global currency war, the deflationary potential effects are increasing on both sides of the Atlantic. The first ECB QE should be supportive for European economies and if not, additional measures will certainly be taken.  Depending on market reactions, the Investment Adviser may maintain the duration risk of the Fund at the current level, 2.8, below a maximum of 3. On the credit side, the ECB QE will be supportive for high grade corporate bonds. The bond selection will be driven by valuation opportunities in both primary and secondary markets. 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 Banque Eric Sturdza in their capacity as Investment Adviser to the Fund as of 18/03/15 and are based on internal research and modelling.