Fears of Grexit and poor liquidity put pressure on Bund, corporate spreads and the ECB

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%, a good non-farm payrolls 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 German government yield curve experienced a bearish steepening this month: the 2y yield stayed at -0.22%, the 5y yield increased from 0% to 0.08% (with a peak at 0.23% on 9th June) and the 10y climbed from 0.49% to 0.76% (+27 bp) with a high on 10th June at 0.98%. 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.

In this context, the Investment Adviser bought Wal-Mart 2026 at 1.83% (Bund + 82 bps) and sold Deutsche Bahn 2021 at 0.78% (Bund + 34 bps). At month end, the Fund held 52 issues and 51 issuers. 

The duration overlay policy was more active this month compared with May due to the Greek crisis. In this uncertain environment, the Investment Adviser decreased the modified duration of the Fund from 2.8 to 2.1.

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. The liquidity of the bond market is an issue and the Investment Adviser will continue to be invested in liquid assets. Depending on the development of the Greek crisis, the Investment Adviser may maintain the duration risk of the Fund between 2 and 2.5. Peripheral spreads will not be considered as a buying opportunity as long as the Investment Adviser is worried about a possible Greek default. On the credit side, the European QE will underpin high grade corporate bonds. The bond selection will be driven by 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 Sturdza Private Banking Group in their capacity as Investment Adviser to the Fund as of 14/07/15.