The ECB will not reach its inflation target despite massive QE

BY ERIC VANRAES

Monthly Fund Commentary
19 May 2016

BY ERIC VANRAES

In April, concerns about Brexit and Greece in Europe combined with the US Presidential election and Dilma’s probable impeachment in Brazil were among the key drivers of the markets, but with a less pronounced impact than the pursuit of the strong rebound of oil prices, from $38.30 to 45.90. Central banks did not change their monetary policies this month. In Europe, the ECB was supposed to start its CSPP program after having raised its QE from EUR 60 to 80 billion/month in March. In the US, the Fed left its rate unchanged but opened the door to raising interest rates in June thanks to an improvement in global financial markets.

In this context, the 2y German yield stayed around -0.48%, the 5y yield slightly increased from -0.33% to -0.29% (+4 bps) and the 10y Bund yield climbed from 0.15% to 0.27% (+12 bps) as investors’ appetite for CSPP bonds was still increasing. On the credit side, the European iTraxx Main stayed around 73 bps while the US corporate CDX index did not move significantly, from 79 to 77 bps (-2 bps).

Following the strategy which was implemented in June 2015, the Investment Adviser continued to favour high quality and liquidity. He sold or decreased the weight of the following names (mostly taking profit on Eurozone governments and PSPP): Netherlands, Belgium, Ireland, KfW, Enexis, TenneT (2020 and 2021), Enel, Sagess, Nederlandse Gasunie and RTE-EdF.

The Modified Duration of the Fund increased significantly, from 2.3 to around 2.8 and the duration overlay policy has been reduced from -1.6 to -1.0. In terms of portfolio diversification, the Fund held 41 issues from 38 different issuers.

The Investment Adviser believes that the ECB will stay ultra-accommodative in the coming months. Mr Draghi already “did the job” at the ECB meeting in March but will not hesitate to implement other unconventional measures if needed. 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. During the last ECB meeting, Mr Draghi announced a decrease of his inflation forecast in 2018 to 1.8%, still below the ECB target of 2%. It means that “Super Mario” admitted implicitly that the ECB will not reach its goal in the coming 2 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 be climbing to the $45-50 range, international issues are unclear (China in particular raises two questions, the exact situation of the economy and the probability of a Renminbi devaluation) and the Fed is still expecting more rate hikes than the market. The Portfolio Manager 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).

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 APP (i.e. PSPP and CSPP). High beta names will be avoided except very short maturities with a “buy and hold until maturity” strategy. The modified duration of the Fund may be maintained above 2.5. The Investment Adviser will pursue this strategy during the following weeks and still believes that positive returns will be achievable as a result of the carry of APP 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 Adviser to the Fund as of 13/05/16.