In March, the major driver of the behaviour of financial markets was, by far, the ECB’s meeting on 10th March. In the global bond market, concerns about a possible Brexit, the US Presidential election and political turmoil in Brazil had a less pronounced impact. However, the strong rebound of oil prices, from $33.70 to $38.30 helped the recovery of risky asset markets to the detriment of safe havens.
In Europe, good PMI indices showed that the Eurozone economy is growing but soft inflation and weak output prices led to greater deflationary fears. In the US, economic data continued to send contradictory signals: the ISM figures were strong but durable goods orders were disappointing and some unemployment data were negative. Regarding Central banks activity, the ECB did not miss its target with an expanded QE (EUR 80 billion / month instead of 60) which will be open to corporate bond purchases, a deposit rate decreased to -0.4% (from -0.3%) and a new TLTRO, which is probably the least commented about measure but the most important. The expanded APP (Asset Purchase Program) will add private corporate bonds (CSPP, Corporate Sector Purchase Program) to government-owned corporates (known as PSPP, Public Sector Purchase Program) towards the end of Q2. The amount of QE now reaches 20% of Eurozone GDP. In the US, Mrs Yellen said that the Fed should “proceed cautiously”. The US Central bankers are probably still in a “wait and see” mode: they are convinced that the pace of the domestic economy deserves a rate hike, but they have difficulty analysing the potential impact of weaker global growth (first and foremost in China) on the behaviour of the US economy.
In this context, the 2y US Treasury yield slightly decreased from 0.77% to 0.72% (-5 bps), the 5y yield stayed at 1.21%, the 10y increased from 1.73% to 1.77% (+4 bps) and the famous 30y long bond stayed at 2.61%. On the credit side, the European iTraxx Main tightened substantially from 99 to 73 bps (-26 bps) after the ECB meeting while the US corporate CDX index rallied from 107 to 79 bps (-28 bps) led by the behaviour of European corporate spreads and the rally of the energy sector after the strong rebound of oil prices.
In March, the Investment Adviser did not change the global strategy which was implemented in June 2015, favouring high quality and liquidity. The Investment Adviser sold Goldman Sachs, Republic of Poland and Procter & Gamble (taking profits). Additionally, the weight of EDF, KfW, Rentenbank, EDC, Cisco and Oracle was decreased. More importantly, the exposure to 30y bonds was amended. Temasek 2042 (AAA Singapore Government) was sold against the purchase of the new US Treasury 2.5% February 2046. Then, the position in the US Treasury 2044 was reduced significantly in order to increase investments in 30y inflation-linked Treasury 2043. In terms of duration, the Investment Adviser increased the modified duration of the Fund from 5.3 to 5.6.
The Investment Adviser believes that the ECB will stay ultra-accommodative in the coming months even if Mr Draghi already “did the job” at the ECB meeting in March. The economic conditions are not particularly improving in the Eurozone with weak growth and, more importantly (as it is the unique mandate of the ECB) low inflation. 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 stabilised around $40 a barrel and international issues are unclear (China in particular raises two questions, the exact situation of the economy and the probability of a Renminbi devaluation). The Fed is still expecting more rate hikes than the market.
The Investment Adviser is still extremely cautious on corporate spreads and on liquidity of the credit market. He will continue to focus his investments on high quality corporates and government agencies. High beta names will be avoided except short maturities with a “buy and hold until maturity” strategy. The modified duration of the Fund may increase towards 6 as any rebound of 30y Treasury yields above 2.75% would be an opportunity to increase investments in long bonds. The Investment Adviser still believes that positive returns will be achievable as a result of the carry of government-owned bonds and high-quality 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 Advisers to the Fund as of 15/04/16 and are based on internal research and modelling.