BY ERIC VANRAES & PASCAL PERRONE
Despite improvements in business confidence, Eurozone growth remained sluggish and inflation fell into negative territory in January for the first time since 2009. Moreover, the International Monetary Fund lowered its forecast for global economic growth to 3.5% in 2015 and 3.7% in 2016. In this context, the European Central Bank (ECB) announced its first Quantitative Easing (QE) program with EUR 60bn of monthly liquidity injections in Eurozone sovereign, supranational and agency bonds form March 2015 to September 2016. This program will increase the ECB’s current balance sheet by almost 50% to more than EUR 3 trillion, representing 10% of Eurozone GDP.
Risk sharing will be limited to 20% as national central banks will be doing most of the buying. This QE will potentially prompt further interest rate easing in sovereigns, supranationals and agencies, but already creates extra demand for corporate bonds. If these measures should prove insufficient, the ECB may opt for additional QE programs as in the US, or increase liquidity injections similar to those seen in Japan. The Swiss National Bank decided (ahead of the ECB QE announcement) to abandon its cap imposed on the Swiss Franc and lowered its deposit rate to -0.75%. This move saw the Swiss currency appreciate massively and sent yields to historical lows. In the US, economic data was disappointing in all segments except housing and consumer confidence. Weakness in the ISM Manufacturing index continued and improvement in employment paused. After shifting to “patient” mode, the Fed indicated that it would not normalise its monetary policy before June, international developments being cited as the main consideration for not increasing interest rates. Despite anticipation of further disinflation effects in the near term, the Federal Open Market Committee (FOMC) expects inflation to rise gradually to its 2% goal over the medium term. With most Central Banks becoming more accommodative and fears of prolonged incertitude in Europe, long end Treasury yields reached new lows.
The German government yield curve expanded its bullish flattening, the 2y yield decreasing from -0.10% to -0.19% (-9bps), the 5y from 0.02% to -0.05% (-7bps) and the 10y from 0.54% to 0.30% (-24 bps). On the credit side, the US corporate Markit CDX Index slightly underperformed the European iTraxx main Index due to the correction in the Oil & Gas sector. The CDX moved from 66 to 70 bps and the iTraxx Index tightened from 63 to 60 bps.
Assets further increased during the month from EUR 111.7 to 116.2 million. The Fund took part in two new deals in the primary market – Volkswagen & BMW. The weight of three positions was increased (Export-Import Bank of Korea, Wendel and Robert Bosch) and two new names were added – AstraZeneca and WPP – for their decent spread/quality and potential beneficiary impact of the ECB’s QE. On the sell side, the Fund decreased its exposure to the Oil & Gas sector and its exposure to Mexico and China by selling Pemex and decreasing the weight of Sinopec. The exposure to the French BBB Edenred was reduced against the increase of Wendel. Volkswagen 2018 and BMW 2022 were sold against the new issues. Finally, the whole position in the peripheral countries (the Italian Enel and the Spanish government agency ICO) was eliminated ahead of the ECB meeting. The Investment Adviser believed that QE was almost fully priced in, but considers that the impact of the victory of Syriza in Greece could push Peripheral spreads wider. Consequently, the risk/reward was too asymmetrical. At month end, the Fund held 47 issues and 46 issuers.
The duration overlay policy was active in January. Corporate bond trades slightly increased the modified duration of the portfolio from 5.7 to 5.8. Concurrently, the Investment Adviser increased the modified duration of the Fund from 2.2 to 2.5 in order to take profit on the yield curve bullish flattening.
With the ECB joining the global currency war, the deflationary potential effects are increasing on both sides of the Atlantic. The first ECB QE should be supportive for European economies and if not, additional measures will certainly be taken. Depending on market reactions, the Investment Adviser may increase the duration risk of the Fund. On the credit side, the ECB QE will be supportive for high grade corporate bonds. The bond selection will be driven by valuation opportunities in both primary and secondary markets. As a consequence, positive returns will still be achievable as a result of the carry of corporates, their spread tightening potential, credit selection and active management of duration and yield curve.
The views and statements contained herein are those of Banque Eric Sturdza in their capacity as Investment Adviser to the Fund as of 17/02/15 and are based on internal research and modelling.