Global Short Duration strategy - May 2024
What’s happening?
Despite the prospect of higher for longer interest rates in the US due to persistent inflation, credit spreads were rangebound, supported by resilient economic data, and continued strong demand.
The US Federal Reserve (Fed) started its two-day meeting on the last day of the month, with expectations for the first interest rate cut being pushed out to December. The European Central Bank (ECB) left its main interest rate unchanged at a record high of 4% with ECB president Christine Lagarde stating she would not wait for the Fed to cut rates before the ECB does. The ECB all but promised a rate cut at its meeting on 6 June, provided there were no inflation surprises. The Bank of England (BoE) did not meet in April, with expectations for the first cut to happen in August.
Sovereign yields rose significantly on the back of higher-than-expected US inflation, with US treasuries underperforming. US inflation rose more than expected to 3.5% in the year to March from 3.2% in February. UK inflation also surprised to the upside at 3.2% while eurozone inflation surprised to the downside at 2.4%.
Portfolio positioning and performance
Sovereign: Our exposure to sovereign bonds was broadly stable at 25% as we continued to switch some nominal debt into US treasury inflation-linked bonds due to stickier-than-expected US inflation, with the exposure to the latter reaching 7%. We also remained invested in German bunds, UK gilts, and government related debt. We increased the duration from mid-month, with a bias towards sterling duration, as sovereign yields rose significantly.
Investment Grade: Our exposure to investment grade markets was unchanged at 57% as we continued to be active in the euro and dollar primary markets. We were also active in secondary markets.
High-Yield and Emerging Markets: Our exposure to high-yield and emerging markets was also largely stable at 15% as we maintained our underweight position due to expensive valuations.
Outlook
A divergence in monetary policy between Europe and the US could appear this year as the latter is faced with stickier inflation on the back of stronger growth, potentially preventing the Fed from cutting rates not nearly as much as the ECB or BoE.
We have reduced the overall level of credit risk as valuations look fair to expensive across most asset classes, particularly in a scenario where the Fed would not cut rates at all for an extended period of time.
Still, we believe the yields available on short-dated bonds remain attractive due to inverted sovereign yield curves and flat credit curves.
No assurance can be given that the Global Short Duration strategy will be successful. Investors can lose some or all of their capital invested. The Global Short Duration strategy is subject to risks including credit risk, liquidity risk and interest rate risk and counterparty risk. The strategy is also subject to derivatives and leverage, emerging markets and global investment risks.
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