The Fed will be more “Patient” than ever…


Fund Commentary
17 Apr 2015


In March, the European economy continued to show signs of improvement while US economic statistics disappointed, despite very good unemployment figures. In Europe, if the recovery seems on track with higher levels of business confidence it must still be confirmed.

The European Central bank (ECB) started its sovereign debt purchasing program on 9 March, buying debt from five major countries: Germany, France, Italy, Spain and Belgium; therefore pushing 10y Italian and Spanish yields to record lows at 1.13% and 1.14% respectively despite the growing risk of another Greek crisis. In the US, unemployment figures were very strong, adding 295’000 jobs leading to a drop in the unemployment rate to 5.5%. These encouraging figures were not confirmed by wage growth which remained sluggish. Other data such as retail sales, housing starts and manufacturing activity decreased sharply. In the meantime, the price of WTI crude oil fell to USD 44 per barrel which is the lowest price in six years. The Federal Reserve (Fed) opened the door to a first rate increase in June but at the same time, confirmed that inflation and wage growth remain too low for them to raise rates in the near future. More importantly, it confirmed that the pace of rate increases will be very slow. Consequently, the median forecast for Fed Fund rates in December 2015 decreased to 0.625%. The Investment Adviser believes that the Fed will stay very pragmatic and could postpone its first rate hike to Q3, Q4 2015 or even early 2016. It seems that once they removed the word “patient” from their statement, US Central bankers have become more patient than even before.

The 2y US Treasury yield decreased from 0.62% to 0.56% (-6 bps), the 5y from 1.50% to 1.37% (-13 bps), the 10y from 1.99% to 1.92% (-7 bps) and the 30y from 2.59% to 2.54% (-5 bps). As a consequence, the 5-30y spread (strategy implemented in the Fund at 151 bps) increased from 109 to 117 bps.  On the credit side, both US corporate CDX & European iTraxx main indexes slightly widened: the CDX moved from 61 to 64 bp and the ITraxx from 50 to 56.

Assets did not move significantly, from USD 123.7 to 124.3 million. The Investment Adviser took the opportunity to buy a block of Sanofi 2021 (French Pharmaceutical Company) and decreased the weight of Nederlandse Waterschapsbank 2015. At month end, the Fund held 47 issues and 41 issuers. 

The duration overlay policy has been very active in March after having been reintroduced in February. The Fund started the month with a short position of 200 5y T-note contracts and a modified duration of 5.4. As the Investment Adviser wanted to adopt a more cautious stance before the publication of the unemployment figures, a short 10y position (150 contracts) was added in order to decrease the modified duration to 4.3. This 10y T-note short position was subsequently reduced to 80 contracts (modified duration: 4.9) and was then switched into an increase of the 5y position ahead of the FOMC meeting (short 260 5y note, modified duration of 5.2). Finally, this position was reduced at month end, such that the Fund held a short position of 200 5y T-note and a modified duration of 5.4, the same as at the end of February. 

With the ECB starting its own QE and continuing to be active in the global currency war, the deflationary potential effects are increasing on both sides of the Atlantic and should maintain demand for yield. The US economic forecasts are still expected to be contradictory; sustained growth and labour market versus falling inflation and weaker economic statistics. The Investment Adviser will maintain the duration risk of the Fund at around 5 during April, as weaker global growth, monetary easing and disinflation underpin duration and flattening of the yield curve, led by the more “patient” behavior of the Fed. On the credit side, corporate bond selection will be driven by opportunities in both primary and secondary markets. As a consequence, positive returns will be achievable as a result of the carry of corporates, their spread tightening potential and credit selection. However, in Q2 2015, the focus will be on active management of duration and yield curve.

The views and statements contained herein are those of Banque Eric Sturdza in their capacity as Investment Advisers to the Fund as of 15/04/15 and are based on internal research and modelling.