DNCA Invest
Flex Inflation

International Multi-strategies Bonds

LU1694790038 (Share A) LU1694789964 (Share I) LU1694790202 (Share B) LU1694790384 (Share N) LU1744459584 (Share ND) LU1728554582 (Share SI)

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Portfolio managers comments | April 2019
April 2019

Looking to growth this month, economic indicators issued in April were lackluster. Stats on the services sector were resilient, but the same cannot be said of the manufacturing sector, which still seems to be suffering the after-effects of the drastic world economic slowdown in the fourth quarter of 2018. If we combine that with the drop in world trade, it is a bad time for large industrial countries, especially those that export, judging by the weak German Ifo and Korean GDP figures. We now seem to have hit rock bottom in the economic slowdown, and while not pre-empting a strong recovery,...

Looking to growth this month, economic indicators issued in April were lackluster. Stats on the services sector were resilient, but the same cannot be said of the manufacturing sector, which still seems to be suffering the after-effects of the drastic world economic slowdown in the fourth quarter of 2018. If we combine that with the drop in world trade, it is a bad time for large industrial countries, especially those that export, judging by the weak German Ifo and Korean GDP figures. We now seem to have hit rock bottom in the economic slowdown, and while not pre-empting a strong recovery, we should at least see a gradual – albeit still shaky – recovery.

Turning our thoughts to inflation, the scenario now emerging is similar to the growth situation: sharp drop yoy in price trends in 1Q, drop in energy prices at the end of the year affecting current indices, and slightly more buoyant prospects with robust labor markets and pressure on oil supply. Initial indicators for April are unanimous with much greater gains than expected (Germany, Japan, Korea, Poland, etc.). Inflation breakevens now look extremely attractive, judging by the substantial gap between economists' projections and market pricing.

For most of the major central banks, 2019 is already almost over in terms of potential changes in monetary policy, and we are likely to see no changes. Patience is the watchword, in light of growth potential and the output gap deemed to be limited. We think that even if our scenario for a stronger rebound in inflation than expected comes off, against the backdrop of a moderate recovery in economic growth, the central banks will not display their usual reaction function. It looks increasingly clear that while not going as far as the inflation targeting theory, central banks will remain accommodative when faced with initial signs of pressure on prices.

Against this backdrop, risky asset prices on the financial markets continued to gain overall, with core country sovereign bonds only seeing moderate rises in yield. In the absence of sharp volatility, risk premiums are falling and helping flatten yield curves. We think that there is no scope for further easing in long-term yields, bar a real sign of monetary easing.

In our portfolio, we steered bond exposure between 4% and 6%. Alongside this solely inflation-linked sovereign exposure, we added inflation breakeven exposure via futures contracts and inflation swaps of close to 15%. This combination helps cut back portfolio volatility considerably and puts us in a solid position to address a less positive bond context.

Over the month ahead, we will remain cautious in light of the end to the economic deterioration and high valuations on the fixed income markets. Scope for further declines in interest rates equates to our adverse scenario (fresh deterioration in growth, cut in leading rates, drop in inflation). Our overall exposure should remain fairly weak overall as compared to the benchmark. The expected recovery in inflation projections should provide a source of value added over the months ahead.

Pascal Gilbert - François ColletText completed on May 02, 2019