By Eric Vanraes and Pascal Perrone
In December, the main drivers of fixed-income markets were deflationary fears (and their spread into the United States), the sharp drop in oil prices, the strengthening of the US Dollar against major currencies (the Euro in particular) and Greece. As a consequence, European Government bond yields kept falling to all time lows fuelled by speculation that the European Central Bank (ECB) will extend its asset purchases to sovereign debt in early 2015. European inflation dropped to 0.3%, its lowest level in over five years.
The ECB confirmed its intention to increase the size of its balance sheet to EUR 3 trillion and its President Mr Draghi said that “all assets but gold are under consideration”. In the US, economic data was very strong: GDP growth (annualised QoQ) climbed from 3.9% to 5% in Q3 and the unemployment figures were excellent with the creation of 321,000 jobs (versus a forecast of 230,000); the previous month saw figures revised from 214,000 to 261,000. The only cloud on the horizon during the month was the Consumer Price Index (CPI): -0.3% MoM leading to a decline of YoY for the Index from 1.7% to 1.3%. As a consequence, it came as no surprise that the Federal Reserve (Fed) modified its monetary policy language; shifting from keeping Fed Fund rates low for “a considerable period” to being “patient”. Finally, and against all odds, the 30 year US Treasury yields continued to fall as a result of an accumulation of fears imported from Europe: deflation, another Greek crisis and the pursuit of the conflict in Ukraine with its consequences on the Russian (and possibly European) economy.
The German government yield curve experienced a bullish flattening, the 2 year yield decreasing from -0.03% to -0.10% (-7bps), the 5 year from 0.11% to 0.02% (-9bps) and the 10 year from 0.70% to 0.54% (-16 bps). On the credit side, neither the US corporate CDX Index nor the European iTraxx main Index saw a significant move: respectively 62 to 66 bps and from 58 to 63 bps. This modest widening was due to the correction of the Oil & Gas sector spreads.
Assets further increased during the month from EUR 108.8 to 111.6 million. The Fund took part in the new Imerys (French Building Materials Company, rated Baa2) deal in the primary market while the weightings of Sanofi and Air Liquide were reduced. At month end, the Fund held 49 issues and 48 issuers.
The duration overlay policy was in full effect in December. Corporate bond trades slightly decreased the modified duration of the portfolio from 5.7 to 5.6. Concurrently, the Investment Adviser decreased the modified duration of the Fund from 2.6 to 2.2 in order to adopt a more cautious stance during the year end transition.
European economic forecasts are still expected to see further cuts and the ECB will accelerate its very accommodating monetary policy due to increasing deflation risk. Depending on market behavior in early 2015, the Investment Adviser expects to adopt a less cautious stance and will again increase the duration risk of the Fund in January. On the credit side, corporate bond selection will be driven by valuation opportunities in both primary and secondary markets. As a consequence, positive returns will be achievableas a result of the carry of corporates, their spread tightening potential, credit selection and active management of duration and yield curve.
Commentary provided by Banque Eric Sturdza in their capacity as Investment Adviser to the Fund as of 16/01/15.