Sterling Credit Short Duration strategy - May 2024
- 11 June 2024 (5 min read)
What’s happening?
Despite the prospect of higher for longer interest rates in the US due to persistent inflation, sterling investment grade 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.
Gilt yields rose significantly on the back of higher-than-expected US and UK inflation. 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
Sterling investment grade primary issuance disappointed in April at only £1.6bn, the second lowest for April in a decade. As a result, we did not participate in any new issues and secondary market activity was limited. Our exposure to financials and BBB-rated bonds remained broadly stable at 45% and 44%, respectively.
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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