The size of Central Banks’ balance sheets matters, not the level of key rates


Fund Commentary
23 Oct 2017


In September, US macroeconomic data (apart from the Institute for Supply Management’s (ISM) manufacturing data) disappointed: data releases indicated decreasing retail sales and consumer confidence.

Throughout the month, President Trump extended the debt ceiling and senators agreed to implement a tax cut plan, reaching $1.5 trillion over the next decade. The Fed maintained its target of one additional rate hike this year, followed by three hikes in 2018, two in 2019 and one in 2020.

Quantitative Tightening is supposed to start with $10 billion per month in October, increasing to $50 billion per month in 2019. Next month, President Trump is likely to unveil the name of the new Fed chair and a list of new Federal Open Market Committee (FOMC) members, including a substitute for Vice-Chairman Stanley Fischer, who will resign in mid-October.

In Europe, Eurozone inflation climbed to 1.5%. The ECB is expected to unveil its tapering program on 26 October, which is likely to include a slow decrease in bond purchases in 2018 (currently accounting for EUR 60 billion per month). France projected the budget deficit to be less than 3%, while Portugal was raised to Investment Grade (i.e. from BB+ to BBB-) by S&P. In Asia, S&P downgraded China’s rating from AA- to A+ due to the increasing debt burden.

In this context:

  • the 2y US Treasury yield increased from 1.33% to 1.48% (+15bps),
  • the 5y yield rose from 1.70% to 1.94% (+24bps),
  • the 10y yield increased from 2.12% to 2.33% (+21bps) and the 30y yield rose from 2.73% to 2.86% (+13bps).

In Europe:

  • the 2y German yield hardly increased from -0.73% to -0.69% (+4bps),
  • while the 5y yield rose from -0.34% to -0.27% (+7bps),
  • and the 10y Bund increased from 0.36% to 0.46% (+10bps).

On the credit side:

  • the European iTraxx Main barely increased from 55 to 57bps, while the US corporate CDX index slightly decreased from 58 to 56bps.
  • In Emerging Markets, the CDX 10y EM index increased from 242 to 251bps (+9bps).


During the month, the Investment Adviser sold the remaining positions in two BBB rated peripheral names, Iberdrola 2020 and Snam 2019 in order to increase the weight of Carlsberg 2023. The Fund also bought the new issue Engie 2023 on the primary market. In order to increase the duration, the Investment Adviser further bought 8 Bund futures, when 10y German rates moved towards 0.5%. As a result, the modified duration increased from 1.1 to 1.4. In terms of portfolio diversification, the Fund held 32 issues from 32 issuers.


Due to outflows mainly coming from investors who sold their holdings in the RMB share class, the Investment Adviser sold the following positions during the month: Tesco 2017, Engie 2017, Siemens 2018 and Toronto Dominion FRN 2018. The team also decreased the weight of Shell 2019, Ford FRN 2019, Roche FRN 2019, Merck 2019, EDP 2021 and US Treasuries 2027 and 2047. The modified duration increased to 5.6. In terms of portfolio diversification, the Fund held 29 issues from 27 different issuers.


During the month, the Investment Adviser slightly decreased the weight of two Investment Grade and Eastern European positions (Hungarian Development Bank 2020 and Romania 2024). In terms of geographical breakdown, the top 3 countries were Mexico (15%), India (12.6%) and China (9.8%). The rating allocation was 58.2% Investment Grade, 39.6% Crossover (BB+ and BB) and 2.2% cash. The breakdown of the portfolio in terms of market allocation was 94.0% Emerging Markets, 3.8% Developed Markets (i.e. Luxembourg/ArcelorMittal) and 2.2% cash. In terms of sector allocation, the Investment Adviser favoured Materials (27.2%) followed by Governments (26.0%) and Energy (21.1%). The modified duration stayed around 5.4-5.5 during the month. In terms of portfolio diversification, the Fund held 37 issues from 37 issuers.


The Investment Adviser’s outlook remains tied to two major topics, inflation and Central Banks’ behaviour. In Europe and the US, inflation is historically low and is likely to persistently remain below target. The current economic situation in the US is probably at a turning point, at which equities are becoming less attractive and long treasuries more interesting.

In Europe, tapering remains the main concern. Should the growth momentum persists and be revised higher, one may expect the ECB to announce a reduction in the monthly pace of their asset purchase program to EUR 40bn for Q1 2018, with a potential 6 to 9 month extension. As a result, BBB spreads could widen (both corporate and peripheral government) and the Bund curve could potentially steepen further.

As a result, the Investment Adviser is very cautious in terms of the European bond market but still believes that long US Treasuries (10 to 30 years) will become increasingly attractive. The team thinks that they could be a top performing asset class in 2018, as a flat slope of the 10-30y yield curve is not excluded. Any correction would be seized by the Investment Adviser as an opportunity to add positions for a medium-long term strategy (outright and/or purchase of 30y bonds hedged by a short 5y future position).

The Investment Adviser will continue to closely monitor the resilience of the global cyclical recovery, G3 Central Bank balance sheets, tapering concerns and geopolitical risks in order to seize any opportunity to reinvest in Emerging Markets. The team thinks that the latter still offer the best risk-reward profile and continue to be supported by low defaults, attractive carry and low supply.

In conclusion, the best performing asset class in a short-medium term horizon is still anticipated to be high quality Emerging Markets but from a medium term perspective (2018 and beyond) long dated US Treasuries look appealing.

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 11/10/17 and are based on internal research and modelling.