Sterling Credit Short Duration Strategy - June 2022

15 July 2022 (5 min read)

Upside surprises on inflation trigger recession fears

Sterling investment grade credit spreads widened significantly due to rampant inflation and recession fears
UK gilt 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, sterling investment grade 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, 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

Sterling investment grade primary issuance recovered to £4bn in June. As such, we participated in two new issues from Finnish bank OP bank and Japanese carmaker Toyota. Our exposure to financials was reduced by 4% and cash increased by 2% following the redemptions of many bonds during the month. Apart from this, we kept the positioning broadly stable, waiting for better entry points before adding risk again, with our exposure to BBB-rated bonds therefore unchanged at 57%.

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.

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 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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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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