Sterling Credit Short Duration strategy - June 2024
What’s happening?
Sterling investment grade credit spreads tightened in May, supported by resilient economic data, continued strong demand, and in-line US inflation. In the UK, prime minister Rishi Sunak announced a general election for 4 July.
The US Federal Reserve (Fed) held interest rates steady at the range of 5.25% to 5.5% in May, stating that it did not expect ‘it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%’. The Bank of England (BoE) also held interest rates unchanged at 5.25%, but governor Andrew Bailey said that he was ‘optimistic that things are moving in the right direction’ and signaled that the first interest rate cut could be made this summer. The European Central Bank (ECB) did not meet but that did not stop president Christine Lagarde from saying that there was a ‘strong likelihood’ of a rate cut in June.
Sovereign yields were mixed, with US treasury yields falling as US inflation was in-line with expectations at 3.4% in April, ending a four-month streak in which inflation outstripped expectations. UK inflation fell to 2.3% in April, its lowest level for almost three years, but the decline was smaller than expected, with UK gilt yields broadly unchanged as a result. German bund yields rose as eurozone inflation rose for the first time this year to 2.6% in May, beating expectations.
Portfolio positioning and performance
Despite sterling investment grade primary issuance picking up to £4.8bn in May, we did not participate in any new issues as they were largely biased towards longer maturities. We were still active in the sterling secondary market. As a result, our exposure to financials and BBB-rated bonds remained broadly stable at 44% for both.
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 sectors, 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 sterling short-dated bonds remain attractive due to an inverted gilt yield curve and flat sterling credit curve.
No assurance can be given that the Sterling Credit Short Duration strategy will be successful. Investors can lose some or all of their capital invested. The Sterling Credit Short Duration strategy is subject to risks including credit risk, interest rate risk and counterparty risk. The strategy is also subject to derivatives and liquidity risks.
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