Trade tantrum or taper tantrum?

In June, the trade war between the US and China, the political situation in Italy and the turmoil in Emerging Markets remained a matter of concern. In the US, the FOMC raised the Fed Funds rate to 1.75%-2% during the month, with Mr Powell’s hawkish speech opening the door for two further rate hikes during the second half of 2018.

Monthly Fund Commentary
24 Jul 2018

In June, the trade war between the US and China, the political situation in Italy and the turmoil in Emerging Markets remained a matter of concern. In the US, the FOMC raised the Fed Funds rate to 1.75%-2% during the month, with Mr Powell’s hawkish speech opening the door for two further rate hikes during the second half of 2018.

The Fed revised its economic projections higher, with the committee likely to adopt a more aggressive policy in order to offset the Trump administration’s stimulation policy.

Unemployment figures were strong, reaching the record low of 3.8% in May. Average hourly earnings growth stood at 2.7% YoY in June, indicating that wage inflation remains under control. In Europe, the ECB unveiled its program for the upcoming months, planning to reduce QE and lowering monthly asset purchases from 30 to 15 billion EUR in Q4 2018, terminating at the end of the year with reinvestments however still continuing. In the Investment Adviser’s opinion, the first rate hike could then take place after two quarters and potentially “during the summer period”. The ECB’s inflation projections have been revised higher to 1.7% in 2018, 2019 and 2020. This said, growth forecasts have been revised lower to 2.1% in 2018, remaining at 1.9% in 2019 and 1.7% in 2020.

According to the Investment Adviser, one thing that came to the attention of market participants was that all of these decisions (tapering at year end and first rate hike in one year) could at any time be called into question should inflation miss the ECB’s target.

In Emerging Markets (EM), Argentina and Turkey were still a source of concern. A higher dollar (DXT reaching the record level of 95 YTD) combined with higher dollar rates led to the continuation of huge outflows in EM funds and ETFs and, consequently, spread widening. According to the Investment Adviser, the markets will during the coming weeks wonder if one is on the eve of a taper tantrum in the Eurozone or a global trade tantrum due to Mr Trump’s protectionist policy, leading to a trade war between the US and China as well as the US and the G6.

STRATEGIC EURO BOND FUND

During the month, the Investment Adviser sold two bonds due to political uncertainties: the Italian Enel 2026 (switched to a Bund 2026) and the Mexican Pemex 2025, prior to the likely election of the new President AMLO on 1st July. The team also decreased the weight of Honda FRN 2019, Total FRN 2020, TenneT 2020 and Enexis 2020 in order to include three new names in the portfolio, Compass 2024 (UK, food services, A), CK Hutchison 2025 (Hong Kong, retail A-) and Mol 2023 (Hungary, oil & gas, BBB-). As a result, the modified duration slightly decreased to 1.7 at month end due to the Pemex sale. In terms of portfolio diversification, the Fund held 28 issues from 28 issuers.

STRATEGIC GLOBAL BOND FUND

In June, the Investment Adviser sold Oracle, maturing in January 2019. The strategy remained unchanged, with the modified duration staying around 5.7-5.8. In terms of portfolio diversification, the Fund held 25 issues from 22 different issuers.

STRATEGIC QUALITY EMERGING BOND FUND

During the month, the team bought Corporacion Financiera de Desarollo 2025 (Peru, government agency, BBB). The Investment Adviser decreased the weight of Mexican issuers substantially from 17% to around 7.6%, selling Pemex 2027, Comision Federal de Electricidad 2027 and Mexico (government bond) 2027. The proceeds have been reinvested in low beta issuers already held by the portfolio, more specifically Poland 2026, Lithuania 2020 and Latvia 2021. Due to the lower maturity of the two Baltic country issues, the modified duration decreased slightly from 5.4 to below 5. In terms of portfolio diversification, the Fund held 32 issues from 32 issuers.

OUTLOOK

As previously reported, the Investment Adviser’s outlook remains tied to two major topics, inflation and Central Banks’ behaviour. This said, inflation fears keep decreasing and the flattening of the US yield curve, combined with other topics such as the neardisappearance of liquidity in the High Yield market, suggest that recession fears will rapidly become a major concern. In addition, after the correction in Emerging Markets and the European periphery, the team are still convinced that high quality bonds, considered as safe havens, will attract more investors during the coming months.

In the US market, the Investment Adviser believes that long US Treasuries (10 to 30 years) remain attractive. The team think that they could be a top performing asset class in the second half of 2018 and that an inverted slope of the curve is not excluded at the end of the year. In the Investment Adviser’s opinion, the Fed could make mistakes because the markets may not be able to absorb additional rate hikes.

As a result, the team think that the best strategy currently is to invest in both floating rate notes (FRNs), as the 3 month Libor dollar is already above 2.30%, and short term corporate bonds yield 3% and above, combined with 30y US Treasuries.

In Europe, the Investment Adviser anticipates that the Bund will follow the behaviour of US Treasuries and, in addition, will perform due to huge outflows from the periphery, Italy in particular.

In Emerging Markets, the Investment Adviser will continue to closely monitor the behaviour of spreads (both governments and corporates) and increasing volatility due to global risk aversion. The team thinks that high-quality Emerging debt still offers a very attractive risk-reward profile, in particular after the recent spread widening, and continues to be supported by low defaults, attractive carry and low supply.

In conclusion, the Investment Adviser still believes that the best performing asset class could be long-dated US Treasuries. Emerging Markets will probably stay volatile during the summer period, with current levels however depicting an attractive opportunity to invest in high-quality EM markets.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 12/07/18 and are based on internal research and modelling.