Sterling Credit Short Duration strategy - April 2024
- 23 April 2024 (3 min read)
What’s happening?
Sterling investment grade credit spreads tightened further, supported by dovish central banks, resilient economic data, and continued strong demand. A surprise interest rate cut from Switzerland’s central bank confirmed that other central banks would not necessarily wait for the US Federal Reserve (Fed) to start cutting first.
The Fed left interest rates unchanged at a range of 5.25-5.5% and held onto its outlook for three cuts this year despite higher-than-expected inflation. As expected, the European Central Bank (ECB) also kept all its policy rates unchanged, with the depo rate remaining at 4% and the first cut still expected in June. Similarly, the Bank of England (BoE) left interest rates unchanged at 5.25%, with no members of the rate setting committee voting for a rate rise for the first time since 2021. Meanwhile, Japan made the historic decision to end its era of negative interest rates with its first rate rise in 17 years.
Sovereign yields fell on the back of dovish central banks. UK gilts outperformed US treasuries and German bunds as UK inflation surprised on the downside, falling to 3.4% in in the year to February, its lowest level for two and half years. Meanwhile, US inflation unexpectedly rose to 3.2% from 3.1% in January while eurozone inflation also surprised on the upside at 2.6%.
Portfolio positioning and performance
Sterling investment grade primary issuance rose in March to £6.2bn. As a result, we participated in four sterling new issues, with a bias towards the financial sector. We were also active in the secondary market. As a result, our exposure to financials increased by 2% to 45% while our exposure to BBB-rated bonds remained stable at 45%.
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 much 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 in 2024.
Still, we believe the yields available on sterling short-dated bonds remain attractive due to an inverted gilt yield curve and flat 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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