Sterling Credit Short Duration strategy - July 2023
Sovereign yields rise as global growth concerns subside
- Sterling investment grade credit spreads tightened as global growth concerns subsided, and the US Federal Reserve paused its rate hiking cycle
- UK gilt yields rose significantly as UK inflation surprised again to the upside
- We reduced further our exposure to BBB-rated debt
- Despite the ongoing slowdown in the Chinese recovery, sterling investment grade credit spreads tightened as the US Federal Reserve (Fed) paused its interest rate hiking cycle, the US avoided a debt default, and global growth concerns subsided.
- While the Fed left interest rates unchanged at 5% to 5.25%, chair Jerome Powell signalled that two further rate hikes were still on the table for this year as inflation makes its way towards the 2% target. The European Central Bank and Bank of England did not follow suit with the former increasing interest rates by 0.25% to 3.50% while the latter lifted them by 0.50% to 50% as inflation failed to fall in May.
- UK gilts significantly underperformed US treasuries and German bunds as UK inflation surprised again to the upside for May, remaining at 8.7%, while jobs growth and wages continued to be strong. As a result, UK gilt yields soared towards levels not seen since 2008.
Portfolio positioning and performance
Sterling investment grade primary issuance rose again to £8.3bn in June. As such, we participated in six sterling new issues, with a bias towards better rated names. We were also very active in the secondary market. As a result, our exposure to A-rated bonds increased by 2% to 29% while our exposure to BBB-rated bonds decreased further by 4% to 48%.
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 caused by the recent banking turmoil. As such, we expect market conditions to remain very volatile with an increased likelihood of a global recession in the second half of this year as central banks’ ability to cut interest rates to support growth is curtailed by elevated inflation.
As a result, we plan to continue reducing the level of credit risk so that we could benefit from a potential widening in credit spreads in the second half of this year by re-risking the portfolio at much better levels.