Government bonds sold off in the early part of March as faster-rising rate expectations and risk-on behaviour drove risk markets higher. Economic data continued to be positive, and employment especially so. This came to an abrupt halt after the US administration’s proposed healthcare bill received such a cold reception from Congress that it was withdrawn without being put to the vote.
Suddenly, expectations of delivery on President Trump’s other fiscal spending projects was questioned, and talk turned to a potential government shutdown in the US in April – Government bonds rallied back once more.
Credit spreads generally held up relatively well throughout, whilst equity markets (other than Japan) in March delivered further positive returns. However, oil prices fell sharply, with inventories looking healthy, and this had an inevitable knock-on impact for the US high yield segment.
Strategy & Positioning
Politics in the US and Europe will continue to dominate the news agenda in the months to come, but the actions of the Federal Reserve and ECB will weigh heavily on markets. We continue to position for the potential effects of further rate rises in 2017, although we are far from convinced that inflationary pressures will be strong enough to force the Fed to move quickly.
Risky assets have already priced in a great deal of stimulus, but the risk rally may have further to run. Against this, we have to consider valuations, which look poor across many asset classes. The upcoming elections in major markets impose the risk of a lurch towards more extreme politics across the European Union. This has been reflected in sovereign bond yields, which look unattractive in many cases.
If we look at the credit market, the heavy oil exposure within the US High Yield sector is of concern, whereas convertible bonds issued by Japanese companies offer significant potential upside in some cases. We continue to be selective and will back those selections with conviction.
The Fund continues to have cash to deploy, and has a degree of credit hedging in place to counter further downside volatility. This has been reduced in recent weeks as the potential causes for volatility recede, but other forms of risk mitigation have been employed, including our options on US duration and reductions in the physical bond portfolio.