A steeper US Treasury curve due to Greece offers buying opportunities on the long end

BY ERIC VANRAES & PASCAL PERRONE

Monthly Fund Commentary
16 Jul 2015

BY ERIC VANRAES & PASCAL PERRONE

In June, the behaviour of the markets has been led by one question: Grexit or Grin, default or rescue plan? Volatility raised sharply, the 10y Bund reached almost 1% but more importantly, liquidity collapsed even in the most liquid markets, government bonds. If the attention was first and foremost focused on the difficult negotiation between Greece and its creditors to prevent a Greek default and/or a Grexit, fixed-income markets continued to follow the publication of US economic statistics.

They were encouraging, dominated by the last revision of the GDP figures for Q1 2015 at -0.2% against -0.7%, good non-farm payroll number (+280k) with an unemployment rate at 5.5% and higher ISM manufacturing index (52.8 v. 51.5), University of Michigan (94.6 v. 90.7) or Philly Fed (15.2 v. 6.7). Inflation was still low, with a CPI (ex-food & energy) at +0.1%. The Federal Reserve (Fed) kept its monetary policy unchanged and the expectations of a first rate hike are expected in September by the most optimistic analysts and in early 2016 for those who believe that the US economy is still too weak and that the Greek crisis is a serious issue that could lead the Fed to postpone the normalization of its monetary policy. In Europe, the discussions between Mr Tsipras and the IMF, the ECB and the European Commission relegated to the second level all the other topics such as economic statistics.   

The US treasury curve experienced a new bearish steepening, 2y US Treasury yield increasing from 0.61% to 0.64% (+3 bps), the 5y from 1.49% to 1.65% (+16 bps), the 10y from 2.12% to 2.35% (+23 bps) and the 30y from 2.88% to 3.12% (+24 bps). As a consequence, the 5-30y spread (strategy implemented in the Fund at 151 bps) increased from 140 to 147 bps.  On the credit side, the US corporate CDX index increased from 64 to 70 bps while the European iTraxx Main widened from 66 to 76 bps.

The Investment Adviser bought two 10y issues, the new US Treasury 2.125% May 2025 and the new Singapore Telecom 3.25% June 2025. At month end, the Fund held 47 issues and 40 issuers. 

The duration overlay policy has been more active this month than in May due to the Greek crisis. In this uncertain environment, the Investment Adviser decreased the modified duration of the Fund from 5.4 to 4.8.

The Investment Adviser believes that the ECB will stay very accommodative and that Mr Draghi will continue his “whatever it takes” policy during the Greek crisis. The Central Bank is ready to intervene to prevent a major market drawdown. In the US, the next FOMC meeting should dampen any aggressive rate normalization anticipation given increased international macro uncertainty. Current higher treasury yields should be considered as a buying opportunity, 30y above 3% in particular. The Investment Adviser still considers that the US economy is not as robust as thought by the consensus and that the Fed will stay very cautious in an environment where every single piece of bad news could lead to a drop in equity markets. As US economic forecasts are still expected to be contradictory, the Investment Adviser will take any opportunity given by the development of the Greek crisis to increase the duration risk of the Fund above 5 during July. On the credit side, corporate bond selection will be driven by opportunities in both primary and secondary markets. Nevertheless, the liquidity of the bond market is an issue and the Investment Adviser will continue to be invested in liquid assets. As a consequence, positive returns will be achievable as a result of the management of duration, the positioning on the US yield curve (long 30y v. short 5y), the carry of corporates, their spread tightening potential and credit selection. 

The views and statements contained herein are those of Sturdza Private Banking Group in their capacity as Investment Advisers to the Fund as of 13/07/15 and are based on internal research and modelling.