Hold your breath before CSPP, the Fed and Brexit (?)


Monthly Fund Commentary
21 Jun 2016


In May, markets seemed to hold their breath before a busy and hectic month of June. In the US, Ms Yellen’s speech pointed out improvements in the US economy, confirming that the Fed is open to raising rates soon. In Europe, concerns about Brexit rose sharply. Polls showed that the outcome is uncertain despite warnings of a collapse of the British economy expressed by all central banks but also the US, China, France, Germany, the IMF, the EU and European Commission… Finally, the only thing that we do know with certainty is that the ECB will start its CSPP (Corporate bond purchases) on 8th June. In this environment, oil prices continued to climb, from $45.9 to 49.1 while gold fell sharply (-6%) from $1,293 to 1,213 an ounce.

In the US, the economy seemed to gain momentum. Labour data was strong (+171k, 5%) and labour costs increased. Retail sales, durable goods orders and industrial production were stronger than expected and the University of Michigan sentiment index rose sharply.

In Europe, the PMI rose to 53, industrial production increased and the labour market improved, particularly in France. This data, combined with the ECB’s aggressive policy should lead to growth of 1.5% in 2016 in the Eurozone.

Central banks did not change their monetary policies this month. In Europe, the ECB confirmed it will start buying corporates in June at a pace of EUR 5 to 10 billion/month. In the US, the release of minutes from the FOMC meeting in April showed that the Fed is ready to raise interest rates at every meeting including on 15th June.

In this context, the 2y German yield slightly decreased from -0.48% to -0.51% (-3bps), the 5y yield decreased more substantially from -0.29% to -0.38% (-9bps) and the 10y Bund yield decreased from 0.27% to 0.14% (-13bps). Consequently, the slope 2-10y flattened (-10bps). Italian and Spanish 10y yields also decreased from respectively 1.49% to 1.35% (-14bps) and from 1.59% to 1.47% (-12bps). Apparently, the market is not particularly focused on the next elections in Spain in June…

In the US, the 2y US Treasury yield increased from 0.78% to 0.88% (+10bps), the 5y yield from 1.29% to 1.37% (+8bps), the 10y from 1.83% to 1.85% (+2bps) and the famous 30y long bond decreased from 2.68% to 2.65% (-3bps). This bearish flattening 2-10y confirmed that the sweet spot in the US curve is the 30y. On the credit side, the European iTraxx Main stayed around 73 bps while the US corporate CDX index did not move significantly, from 77 to 76 bps (-1bp). In Emerging Markets, the CDX 10y EM index spreads widened from 311 to 331 bps with a spike reaching 345 bps on 23rd May.



Following the strategy implemented in June 2015, the Investment Adviser continued to favour high quality and liquidity. He sold or decreased the weight of the following Government bonds and PSPP: KfW 2020, Snam 2016, Belgium 2020 and Terna 2018. At the same time, he increased the weight of CSPP names, buying three new issuers: Total 2021 (Oil & Gas, France), Iberdrola 2020 (Oil & Gas, Spain) and ENI (Oil & Gas, Italy). He also took profit on some low-yielding BBB names, selling the whole position in TeliaSonera 2017 and decreasing the position in Wolters Kluwer 2018. The Modified Duration of the Fund increased slightly, from 2.7 to around 2.9 and the duration overlay policy has been increased from -1.0 to -1.2. In terms of portfolio diversification, the Fund held 41 issues from 39 different issuers.



As with the Euro Bond Fund, the Investment Adviser did not change the global strategy implemented in June 2015, favouring high quality and liquidity. Following the minutes of the April FOMC and Ms Yellen’s comments, he partly took profit on the huge 30y Treasury position, selling USD 5 million US Treasury 3% 2045, switched against a US T-bill maturing in December 2016. Consequently, the modified duration of the Fund, which had been raised to 5.9 when 30y yields reached 2.75%, decreased to 4.5. In terms of portfolio diversification, the Fund held 30 issues from 27 different issuers.



After the inception of the Fund on 28th April with USD 35 million, the Investment Adviser began building the portfolio in May with a cautious stance. 31 issues were bought in order to provide sufficient diversification. In terms of geographical breakdown, the top 3 countries were Russia (20%), Turkey (17%) and Brazil (8%). The top 3 sectors were Financials (26%), Energy (22%) and Basic Materials (14%). The rating allocation was 55% BB, 39% BBB and 3% A (and 3% cash). The modified duration reached 6.2 at month end.



Regarding Europe, the Investment Adviser believes that the ECB will stay ultra-accommodative in the coming months. Mr Draghi will not hesitate to implement other non-conventional measures if needed, in the case of Brexit for example. The economic conditions are slightly improving in the Eurozone but not enough to prompt the ECB to modify its policy or for Bund yields to climb substantially. The problem is still low inflation and, as the Portfolio Manager already mentioned in the last report, Mr Draghi announced a decrease of his inflation forecast in 2018 to 1.8%, still below the ECB target of 2%. This means that “Super Mario” admits implicitly that the ECB will not reach its inflation goal during the next two years. Regarding the Fed’s policy, the behaviour of the FOMC in 2016 is still unclear: inflation is low but will increase gradually (due to the base effect after the sharp decrease of oil prices in 2015), oil prices seem to have reached the $50 level, international issues are unclear (Brexit today but do not forget China) and the Fed is still expecting more rate hikes than the market. The Investment Adviser still believes that there will be no more than one rate hike this year and that the probability of zero hikes will increase gradually (simultaneously with the probability of a recession in 2017). He will stay overweight 30y US bonds (both Treasuries and TIPS). Emerging Markets will stay volatile but the current environment, with low yields in US, Europe and Japan, higher commodities and oil prices, stabilisation of emerging currencies and a “nottoo- hawkish” Fed leave room for further spread tightening. But, obviously, all eyes will focus on polls in UK in June, waiting for the 23rd June verdict…


The views and statements contained herein are those of the Eric Sturdza Private Banking Group in their capacity as Investment Advisers to the Fund as of 13/06/16 and are based on internal research and modelling.