Global Short Duration strategy - August 2023
UK gilt yields fall as UK inflation surprises to the downside
- Credit spreads tightened on the back of receding fears of recession in the US and Europe
- UK gilts significantly outperformed US treasuries and German bunds as UK inflation surprised to the downside
- We continued to reduce our exposure to high-yield due to expensive valuations
- Credit spreads tightened on the back of positive economic data, including receding fears of recession in the US and Europe, further stimulus measures in China, a positive earnings season, and falling inflation.
- The US Federal Reserve resumed interest rate hikes in July after pausing in June, increasing by 0.25% to a range of 5.25% to 5.50%. Meanwhile, the European Central Bank delivered another 0.25% rate rise to 3.75%. There was no Bank of England monetary decision in July but markets had priced in a 0.25% rise in August, potentially taking the cost of borrowing to 5.25%.
- Yields on US treasuries and German bunds rose while UK gilt yields fell, with the front-end significantly outperforming, as UK inflation for June surprised to the downside at 7.9%. Meanwhile, US and eurozone inflation also fell to 3.0% and 5.5%, respectively.
Portfolio positioning and performance
- Sovereign: Our exposure to sovereign bonds increased by 3% to 16% as we bought some US treasuries and added to UK gilts. We also remained invested in German bonds, UK inflation-linked bonds and government guaranteed debt. We kept the duration close to three years for most of the period, benefiting from the sharp fall in UK gilt yields at the front-end.
- Investment Grade: Our exposure to investment grade markets was stable at 60% as we kept our overweight in the sterling investment grade market due to attractive yield opportunities.
- High-Yield and Emerging Markets: Our exposure to high-yield and emerging markets decreased by 3% to 22% as we further reduced our exposure to European and US high-yield due to expensive valuations.
- The macroeconomic outlook remains very uncertain given high (but falling) inflation, rising (but peaking) interest rates, slowing (but resilient so far) growth and tighter lending conditions. As such, we expect market conditions to remain very volatile with an increased likelihood of a global recession late this year or early next year as central banks’ ability to cut interest rates to support growth is curtailed by still elevated inflation.
- With valuations looking fair to expensive, we plan to continue reducing the level of credit risk gradually so that we could benefit from a potential widening in credit spreads late this year or early next year by re-risking the portfolio at much better levels.