Rates – Time to watch out.
For investors, it is time to take the move in rates more seriously. YTD, US 10y yields have moved 40bp higher, from 0.9% to 1.3%. Rising swap spreads are leading the selloff, signalling exacerbating hedging activity. So far, the impact on risk assets has been limited. Higher rates went with higher growth hopes and stronger risk. The only casualties have been IG bonds, given low yields. Going forward, the correlation may change. HY credit yields around 3%, and growth stocks outperformed for long in equity. Treasuries at 1.5% or higher would lead to a swifter adjustment, with equities and HY credit turning weaker. While the Fed may step in, any relief may be temporary. Inflation is likely to materialize in Spring already, and Yellen has been publicly pushing for more stimulus. So a pause may be in order, but the direction of rates is up. We believe the belly of the UST curve is next to follow the underperformance of the long-end, and are positioned to benefit through options.
Positioning – Flexibility pays off.
Given tight spread and rising rates, we maintain a flexible positioning. First, we maintain a high allocation to cash coupled with a few high-conviction longs. Since credit is not cheap, we prefer to focus on improving stories and keep a buffer for volatile times. Second, we focus our longs on areas that still have upside, such as convertible debt or cyclical credits. Last, we hedge the rates risk by shorting duration and protect credit risk via long CDS in indexes. As a result, our portfolio benefits from stronger risk assets but is relatively isolated from rates and spread widening, and keeps enough ammunition in case a selloff starts making valuations in credit interesting again. In 2021, our Global Credit Opportunities Fund returned 2%, against 0.72% in US HY, and -2.5% in US IG.
Central Bank Minutes – Too early to talk tapering.
The ECB stated “cautious optimism” for the 2021 recovery and focused their minutes on financing conditions, mentioned 25 times, which were seen as favourable until the January meeting. According to the committee, any spillover from higher US to EUR rates does not necessarily tighten conditions and therefore does not automatically warrant a policy response. The FED reiterated that they would announce tapering well ahead of time, and urged market participants to look through any transitory changes in inflation from supply constraints.
Italian Politics – Super Mario is back.
In his first speech as PM last week, Mario Draghi detailed his political programme. He explained his intentions to accelerate the country’s vaccine rollout, outlined his plans to invest €210bn of EU recovery money, as well as plans for structural reforms of Italy’s legal system and public administration. While there will be no easy fixes to Italy’s current social and economic situation, we believe the new Italian government, backed by a large majority, has the potential to transform a deep crisis into an opportunity to tackle some of the structural weaknesses that have plagued the Italian economy for decades. With a more rationale government, we believe the BTP-Bund spread could tighten by another 10-15bps from current levels.
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