The Fed more predictable than the ECB?

In August, the trade war between the US and China continued to escalate. At the same time, Turkey triggered Emerging Markets fears, with Italy remaining the main source of concern in the Eurozone.

Fund Commentary
25 Sep 2018

In August, the trade war between the US and China continued to escalate. At the same time, Turkey triggered Emerging Markets fears, with Italy remaining the main source of concern in the Eurozone.

In the US, the curve kept flattening against the backdrop of various factors such as:

  • tariff threats,
  • sanctions against both, Iran (and its impact on oil prices) and Turkey (after all a NATO member),
  • an increasing risk of a monetary policy mistake by the Fed,
  • central banks’ purchases and
  • the pursuit of a “double fly to quality” (safe debt denominated in a safe currency).

The Jackson Hole meeting did not reveal any interesting news this year. Mr Powell mentioned that the next rate hike is scheduled for September and that another hike is probably in the cards for the last meeting of the year in December.

In his speech, he explained the Federal Reserve’s mission and the methodology applied to make monetary policy decisions. According to the Investment Adviser, Powell was actually not speaking to the audience but rather to Mr. Trump, who had previously publicly criticised the Fed, calling its independence into question.

In Europe, inflation started to climb (to 2.1% in the Eurozone and 2.6% in France), with core inflation however remaining at a low level of 1.1%. Whilst Greece officially recovered from its crisis, Italy became an alarming concern. At the same time, growth is beginning to falter in the Eurozone. In France, the government for instance revised its growth outlook from 1.9% to 1.7%. Against this backdrop, the Investment Adviser doubts that the ECB will adopt a very hawkish tone on 13th September.


During the month, the Investment Adviser continued to implement the Fund’s new strategy. In order to optimise the risk/return profile, the team increased the weight of subordinated debt (both Tier II bank debt and hybrid corporates), with Santander 2025, yielding 2.07%, Total hybrid at 2.60%, Telefonica hybrid at 3.60% and Volkswagen hybrid at 4.22%. At the same time, the team sold the remaining stake in Enexis 2020, yielding -0.06%.

The Investment Adviser further switched the remaining position in IBM 2020, yielding -0.01%, into Femsa 2023 at 1.00%. Finally, the team slightly decreased the weight of SDBC 2021, close to 5%. As a result, the modified duration barely increased from 3.3 to 3.4 during the month. In terms of portfolio diversification, the Fund held 30 issues from 30 issuers.


This month, the Investment Adviser reduced exposure to 30yr Treasuries in order to increase the weight of short duration corporate bonds, yielding above 3%. A new name was added to the portfolio, more specifically the French bank BFCM 2020 at 3.25%. In addition, the weights of Hutchison Whampoa 2022, yielding 3.59% and Telstra 2021, yielding 3.49%, have been increased. The barbell strategy was slightly reduced this month, overall however remaining in place, with the modified duration lowered from around 5.4 to 4.6. In terms of portfolio diversification, the Fund held 26 issues from 23 different issuers.


During the month, the Investment Adviser reduced the weight of South Africa Government from 2.5% to 1.2%. The Fund’s modified duration hardly decreased from 5.3 to 5.2. In ter ms of portfolio diversification, the Fund held 33 issues from 33 issuers.


The Investment Adviser’s outlook is tied to two major topics, inflation and positions adopted by Central Banks. Inflation risk remains subdued and the US yield curve continues to flatten. In combination with other topics such as an escalation of trade war risk, these factors suggest that recession fears will rapidly become a major concern. In addition, after the recent correction within Emerging Markets and the European periphery, the team is still convinced that high quality bonds, considered as safe havens, will attract more investors during the coming months.

In the US market, the Investment Adviser believes that long US Treasuries are still attractive, believing that they could be a top performing asset class in the second half of 2018 and that an inversion of the curve’s slope is not excluded at the end of the year. According to the team, the Fed may be making a mistake by pursuing the normalisation of its monetary policy, with the markets not having the capacity to absorb additional rate hikes. The Investment Adviser thinks that the best strategy today is to invest in short term corporate bonds yielding above 3% combined with 30y US Treasuries.

In Europe, the Investment Adviser thinks that the Bund will match the behaviour of US Treasuries and, in addition, will perform well should there be a resurgence of tensions in the periphery, particularly in Italy.

Within Emerging Markets, the Investment Adviser will continue to closely monitor the behaviour of spreads (both governments and corporates) and increasing volatility due to global risk aversion. With increased performance dispersion, the team thinks that high-quality Emerging debt still offers a very attractive risk reward profile, in particular after the recent spread widening, and continues to benefit from both attractive valuation and encouraging technical factors.

In conclusion, the Investment Adviser still believes that the best performing asset class to be long-dated US Treasuries, and expects the curve to keep on flattening during the second part of the year. Emerging Markets will probably stay volatile during the summer but if either trade or rates concerns ease, current levels offer an attractive opportunity to invest in high-quality EM markets in the team’s opinion.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 13/09/18 and are based on internal research and modelling.