Market Development: During August, there was very little movement in long-term US Treasury yields, despite some potentially bad news for the bond market: the unemployment rate and inflation both reaching 5.4% and the confirmation of tapering in the near future at the Jackson Hole meeting.
On the other hand, COVID (the delta variant) is still a threat to the growth outlook and the first signs of a slowdown materialised (or at least the end of the V-shaped recovery). Apparently, the Fed seems convinced that the high inflation is temporary and 943,000 job creations are not enough to modify their monetary policy.
Finally, the Jackson Hole meeting did not bring any news that we did not already know. Jay Powell’s speech was slightly more dovish than expected, postponing official decisions on tapering to the September (or December) FOMC meeting. As a result, credit spreads were still performing well, following the equity markets and their euphoria. In the corporate debt space, hybrid bonds rallied significantly and became expensive. Emerging Markets were still a source of concern, driven by the widening of some Chinese credit spreads.
Our outlook remains focused on the macroeconomic situation (including growth, inflation and unemployment), Central Banks’ behaviour (the timing of tapering and its size) and the evolution of equity markets. At the same time, the COVID pandemic – due to the spread of the delta variant – is not over and the delays in vaccination plans in some regions are affecting the recovery in Emerging Markets (Latin America and Asia ex-China in particular).
Inflation fears in the US have decreased, and the behaviour of the Fed towards tapering could become the major source of concern. The Fed will probably wait for the last FOMC meeting of the year (on 3rd December) to unveil its program. We are becoming concerned by the outlook of economic growth for Q1 2022. As a result, tapering could be lower than expected or potentially postponed should growth and unemployment disappoint. We, like the Fed, believe that consumer prices should come down in Q4.
In the US, the Treasury yield curve could stay at the levels reached this summer. Fed purchases and strong demand for safe-haven assets should stabilise long-term yields at reasonable levels. In Europe, the ECB should continue to be ultra-accommodative, despite the announcement of a very small reduction of its Public Sector Purchase Programme.
Some high-quality Emerging Markets could offer investment opportunities, driven by demand and the weakness of the US dollar, but the political and health situations in Latin America are, for the time being, too risky and uncertain to consider investing in this region. China is becoming a concern too, and the evolution of credit spreads must be watched carefully. On the other hand, this could create investment opportunities in high-quality Chinese corporates.
As a result, we are of the opinion 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 (both in EUR and USD). Hybrid debt is becoming expensive: the objective is to keep the existing position for the carry of the spread, but not dramatically increasing the weight of this asset class.
High-quality credit spreads are still attractive in the current environment and we intend to keep buying long maturities (7-10y instead of 3-5y), while partially hedging their higher duration through a duration overlay policy.
We continued our strategy in August, slightly increasing the weight of Deutsche Telekom and marginally reducing the duration overlay policy with the purchase of 10 US 10y Note future contracts.
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.
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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 17/09/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.