There will be no summer break for Central banks


Fund Commentary
26 Jul 2017


In June, US economic data was disappointing as consumption, production and business confidence decreased. On 14th June, the Fed raised its Fed funds target range from initially 0.75%-1% to 1%-1.25% and unveiled its plan to shrink its balance sheet (by USD 10 billion/month, including 6 billion of Treasuries and 4 billion of Mortgage-Backed Securities).

Ms Yellen did not mention when the program will be implemented. At the same time, the IMF cut its 2017 growth forecast for the United States (again) from 2.3% to 2.1%. In Europe, growth seemed to expand at the fastest pace, particularly in Germany, France, Spain and Italy. As a result, investors continued to bet on a probable tapering by the ECB in 2018, despite Mario Draghi’s comments, that a considerable degree of monetary accommodation is still needed for inflation dynamics to become durable and self-sustaining. In addition, the two major events this month were the victory of Emmanuel Macron’s party at the French Parliamentary elections and the takeover of Banco Popular by Santander in Spain (leading to the collapse of EUR 1.25 billion AT1 bonds).

In this context, the 2y US Treasury yield increased from 1.28% to 1.38% (+10bps), the 5y from 1.75% to 1.89% (+14bps), the 10y from 2.20% to 2.30% (+10bps), while the 30y yield decreased from 2.86% to 2.83% (-3bps) throughout the month. At the same time, the 30y inflation-linked Treasury yield increased from 0.90% to 0.98%, leading to a further decrease of the inflation breakeven from 1.96% to 1.85%. In addition, the 3 Month USD LIBOR increased from 1.21% to 1.30%.

In Europe, the 2y German yield increased from -0.71% to -0.57% (+14bps), the 5y from -0.43% to -0.22% (+21bps) and the 10y Bund from 0.30% to 0.47% (+17bps), after having reached a low of 0.23% on June 14th. At the same time, France, Italy and Spain outperformed the Bund. The French 10y OAT yield increased from 0.73% to 0.82% (+9bps) following the positive election outcome, while the Italian BTP 10y and the Spanish 10y bond yields decreased from 2.20% to 2.16% (-4bps) and from 1.55% to 1.54% (-1bps) respectively vis-à-vis reduced political uncertainties. On the credit side, the European iTraxx Main decreased from 62 to 53bps, its lowest level of the year, driven by the tightening of French corporate spreads, while the US corporate CDX index slightly decreased from 61 to 60bps. In Emerging Markets, the CDX 10y EM index increased from 251 to 262bps (+11bps).


During the month, the Investment Adviser slightly decreased the weight of Siemens 2018. The Modified Duration also decreased slightly from 1.26 to 1.14. In terms of portfolio diversification, the Fund held 35 issues from 34 different issuers.


During the month, the Investment Adviser took the decision to increase the weight of Schaeffler Finance. The modified duration slightly increased from 4.96 to 5.02. In terms of portfolio diversification, the Fund held 35 issues from 32 different issuers.


During the month, the Investment Adviser added a new issuer to the portfolio, Fresnillo (Mexico, BBB, world’s leading silver producer and Mexico’s largest gold producer). In terms of geographical breakdown, the top 3 countries were Russia (16.6%), India (10.4%) and China (9.9%). The rating allocation was 58.4% Investment Grade, 35.4% Crossover (BB+ and BB) and 6.2% cash. The breakdown of the portfolio in terms of market allocation was 90.1% Emerging Markets, 3.7% Developed Markets (i.e. Luxembourg/ArcelorMittal) and 6.2% cash. In terms of sector allocation, the Investment Adviser favoured Governments (33.5%) followed by Materials (23.6%) and Energy (15.7%). The modified duration decreased from 5.23 to 5.08 during the month. In terms of portfolio diversification, the Fund held 34 issues from 34 different issuers.


The Investment Adviser’s outlook is tied to two major topics, inflation and Central Banks behaviour. In Europe and the US, inflation is low and will stay low. The current economic situation in the US is probably at a turning point, where equities are becoming less attractive and Treasuries more interesting. The bond market sent a signal in June: the Fed’s rate hike has led to a 15 bps rally of the 10y Treasuries from mid June onwards. The curve is flattening and will probably flatten further in the coming months when the Fed will be more cautious. This June hike could be the last one in 2017.

In Europe, tapering is a concern. Should the ECB decrease its QE next year, BBB spreads could widen significantly (both corporate and government) and the Bund curve could potentially steepen further. As a result, the Investment Adviser is very cautious in the European bond market but still believes that US Treasuries will become more and more attractive. They, especially the long dated ones, could be a top-performing asset class in 2018, as an inversion of the slope of the 10-30y 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. The Investment Adviser will continue to monitor the resilience of the global cyclical recovery and the evolution of high beta Emerging Markets closely, in order to seize any opportunity to reinvest in these regions, which probably still offer the best risk-reward profile and will remain supported by low defaults, attractive carry and low supply.

In conclusion, the best performing asset class in a short-medium term horizon is still high quality Emerging Markets. However, from a medium term perspective (2018 and beyond) investors should consider start building positions in long-dated US Treasuries.

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 14/07/17 and are based on internal research and modelling.