Sterling Credit Short Duration strategy - May 2022
- 13 July 2022 (5 min read)
Volatile month as inflation reaches new highs
- Sterling credit spreads widened further due to continued concerns around central bank tightening
- UK gilt yields rose as the rate of inflation in the UK jumped further
- We resumed the re-risking by mostly increasing our allocation to financial subordinated debt
What’s happening?
Sterling credit spreads widened in the first half of the month driven by concerns over central bank tightening, rampant inflation, and China’s zero-tolerance policy towards COVID-19. However, as the market dialed back expectations for interest rate rises in the US due to recession fears and China relaxed some of its COVID-19 restrictions, sterling credit spreads tightened but still finished the month wider.
The US Federal Reserve (Fed) raised interest rates for a second consecutive time by 0.5% to the range of 0.75% to 1% in a bid to slow down inflation. Meanwhile the Bank of England (BoE) raised interest rates for a fourth consecutive time from 0.75% to 1%, the highest in 13 years, as the rate of inflation in the UK jumped further in April to a 40-year high at 9%.
UK gilt yields rose as the market focused on the impact of rising inflation on the future path of interest rates.
Portfolio positioning and performance
Sterling investment grade primary issuance fell to just £1.4bn in May, the slowest month of supply year-to-date. As such, we only participated in one new issue from German bank Deutsche Bank. We were still active in the sterling secondary market, mostly adding to attractive opportunities in financial subordinated debt and increasing our exposure to it by 4% to 14%. This led to an increase in our exposure to BBB-rated names of 3% to 57%.
Outlook
We expect market conditions to remain very volatile over the medium-term due to the combination of continued inflationary pressures, hawkish central banks and a protracted conflict in Ukraine. In such an environment, it is paramount to retain flexibility and manage actively the credit exposure.
As inflation should start gradually falling over the coming quarters, we expect gilt yields to stabilise at these higher levels since they already reflect a very aggressive pace of tightening by the BoE, helping sterling credit spreads to tighten.
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.
What are short duration bonds?
A short duration bond is generally a bond with a short time to maturity. At AXA IM we define this period as 5 years or less.
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The aim of the strategy is to provide income combined with any capital growth.
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The value of investments, and the income from them, can fall as well as rise and investors may not get back the amount originally invested.