Global Short Duration strategy - June 2022

15 July 2022 (5 min read)

Upside surprises on inflation trigger recession fears

Credit spreads widened significantly due to rampant inflation and recession fears
Government bond yields were higher despite the large sell-off in risk assets
The risk profile was broadly unchanged

What’s happening?

Despite the easing of COVID-19 quarantine restrictions in China, credit spreads widened significantly due to rampant inflation and increased recession fears as central banks pressed ahead with interest rate hikes.

The US Federal Reserve raised interest rates for a third consecutive time by 0.75% to the range of 1.5% to 1.75%, its biggest hike since 1994, as inflation surprised to the upside in May at 8.6%, a 40-year high. Meanwhile the Bank of England raised interest rates for a fifth consecutive time by 0.25% to 1.25% as inflation reached 9.1% in May, also a 40-year high. Finally, the European Central Bank struck a hawkish tone at its policy meeting and is expected to announce an interest rate rise in July as inflation reached a new record high of 8.6% in June.

Despite the large sell-off in risk assets, US treasury, German bund and UK gilt yields rose as the market focused on the impact of still rising inflation on the future path of interest rates.

Portfolio positioning and performance

Sovereign: Our exposure to sovereign bonds was broadly stable at 13% (versus 12% last month) as we remained invested in US, German and UK inflation-linked bonds to benefit from still attractive inflation indexation over the next couple of months. We increased the duration of the portfolio to 2.9 years from 2.7 years due to attractive valuations and rising recession risk which should support government bonds.

Investment Grade: Our exposure to investment grade markets was unchanged at 48% as activity was limited with only one new issue being bought in the US dollar primary market.

High Yield and Emerging Markets: Our exposure to high-yield and emerging markets decreased by 2% to 37% as we reduced our exposure to US high-yield due to the risk-off environment. We are waiting for better entry points before adding back to these asset classes.

Outlook

We expect market conditions to remain very volatile over the short-term due to continued inflationary pressures, hawkish central banks, a protracted conflict in Ukraine and increased risk of a recession next year. In such an environment, it is paramount to retain flexibility and manage actively the duration and credit exposure.

As inflation should start gradually falling over the coming quarters, we expect yields to consolidate at these higher levels since they already reflect a very aggressive pace of tightening by central banks, helping credit spreads to also stabilise.

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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Fixed Income

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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