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CURRENCIES
Strong volatility of equity markets following the bankruptcy of SVB reinforces our Neutral position on the asset class. We maintain our preference in European markets due to a deeper tightening of credit conditions in the US and a more favorable momentum in European profits.
US. We maintain our Underweight position in the U.S. market. The US economy remains very resilient in the face of the strong monetary tightening over the past year (+475bps), although the bankruptcy of SVB will further tighten credit conditions. Indeed, bank credit to companies is expected to slow down significantly due to the difficulties of the regional banks. Overall, the economic slowdown is expected to be accompanied by a slowdown in profits while financial conditions are expected to remain broadly restrictive, weighing on both Growth and Value stocks. In addition, banking stocks, including regional banking stocks, are an important component of Value indices, which until now had shown good resilience. All these elements lead us to remain Underweight on US equities and we prefer Quality stocks to Growth and Value stocks.
UK. We remain overweight in UK equity markets. The UK equity market has also suffered from the collapse of SVB and subsequent contagion across the continental European banking sector, notably following the accelerated acquisition of Credit Suisse. If the UK economy is indeed expected to contract, UK equities should perform well due to their sector composition and cyclical exposure to rapidly recovering Asian economies.
Eurozone. Before the advent of the banking turmoil, European stocks performed well due to several factors. Economic activity and the labor market remain resilient, particularly in the services sector, following the easing of energy tensions and the reopening of the Chinese economy. In addition, corporate profits remain on a good dynamic, with strong growth in nominal and real terms. While the SVB bankruptcy and subsequent crisis at Credit Suisse have also resulted in a correction in European stocks, particularly banking stocks, these declines do not seem to us to reflect the dynamics of European growth or the good liquidity and solvency situation of European banks. We therefore remain Overweight in European markets, given the profit outlook and attractive valuations, with a preference on value stocks and defensive sectors.
Japan. We remain underweight in the Japanese equity market. Against the tide, the Bank of Japan maintained its accommodative policy, with a negative interest rate of 0.1%, which maintains downward pressure on the Yen and high hedging costs.
Emerging markets. We maintain our Neutral stance on emerging equity markets. Weekly data confirm the recovery of economic activity in China, with an improvement in industrial production and retail sales, as well as a moderate contraction in the real estate sector. This economic recovery is due to the end of Covid measures, and the catching up of household consumption, which still has a fairly significant surplus of liquid savings. The rebound of the Chinese economy is expected to have a positive effect on the economies of the region.
Style Preference
Bank equity indices and main indices
Past performance does not prejudge future performance. Investments may be subject to market fluctuations, and the price and value of investments and the resulting revenues may fluctuate downward and upward. Your capital is not protected, and original investments may not be recovered.
Sovereign rates have been very volatile, with short-term rates rising significantly on fears of inflation to then falling sharply with the rise of fears around the stability of banking systems. Against this backdrop of high market volatility, we are maintaining our neutral position on the government bond market.
US. US Treasury rates have seen some turbulence over the last month. Indeed, the 2-year rate initially climbed to 5% due to resilient data for the labour market and inflation. The latter is only gradually coming down, to 6% for inflation and 5.5% for core inflation. However, following the SVB bankruptcy, 2-year rates fell sharply, recording the largest daily decline since 1987 and returning to their level of the beginning of the year. Long rates also fell, with the 10-year rate below 3.5%. These movements illustrate expectations that the shock to banks is affecting credit activity and weighing on the economy and ultimately on inflation. Undeterred by the banking turmoil, the Fed raised rates by 25 bps to 5.00% and removed references to “ongoing increases” from its official meeting minutes, suggesting a likely pause to its tightening regime. We remain overweight Treasuries, as they still offer a positive real return and are once again playing their role as a hedge against risk aversion.
Duration Preference
UK. Gilts have also been on the upswing and downswing in recent days. The 10-year rate has also fallen below 3.5%. Headline and core inflation surprised on the upside in February, rising 10.4% and 6.2% on the back of surging food prices. Economic activity is very weak and financial risks are particularly present (variable rates on mortgages), prompting the Bank of England to raise its rate by 25 bps to 4.25% and likely keep it stable in the coming months. We therefore remain Neutral.
Eurozone. Sovereign rates in the euro area also showed strong volatility. The 2-year OAT fell from 3.4% to 2% following the SVB bankruptcy and fears of contagion to the European banking system. The 10-year OAT also fell from 3.1% to 2.7%. In contrast, sovereign risk premiums remained broadly stable, with the Italian-German 10-year spread below 200 bps. The economic situation in the euro area is similar to that of the US in that economic activity remains resilient, particularly in services, while labour markets remain dynamic. However, unlike the US, while headline inflation is decelerating due to lower energy prices, core inflation continues to accelerate, reaching 5.6% in February. Against this backdrop, the ECB has raised rates by 50 bps to 3.00% and signaled that future rate hikes will be linked to price developments and market tensions. We expect another 50 bps rise before rates stabilise for the long term. We therefore remain Neutral on eurozone bonds in view of the ECB's tightening still to come.
Developed markets. We remain underweight on Investment Grade and High Yield debt given the risk in a context of economic slowdown and financial tensions.
2-year sovereign rates
Past performance does not prejudge future performance. Investments may be subject to market fluctuations, and the price and value of investments and the resulting revenues may fluctuate downward and upward. Your capital is not protected, and original investments may not be recovered. Duration: short = Up to 5 years, medium = 5-7 years, long = 7+ years.
The dollar has remained generally stable in recent weeks against major developed currencies. We remain overweight on the Euro and Sterling due to the continued improvement of external balances and an interest rate differential that is expected to narrow.
Dollar Index. The dollar has regained ground against the major emerging currencies over the past month due to financial fears following the SVB bankruptcy. While on the one hand the expected slowdown in the Fed's rate hike cycle should be supportive of emerging and developed currencies, financial stability concerns could support the dollar in the coming weeks.
GBP/USD. The pound has appreciated slightly against the dollar due to the widening rate outlook. This trend is likely to continue in the coming weeks due to less external pressure (less perceived political risk and improving trade accounts) and the expectation that the Bank of England will continue its monetary tightening.
EUR/USD. We remain overweight on the euro/dollar exchange rate. The European currency has remained broadly stable over the past month, mainly reflecting the narrowing of the spread between the rate and the dollar rate. However, we believe that the euro should regain ground in the coming weeks due to the return of European external surpluses and an ECB that should also maintain a restrictive bias, allowing for a tightening of interest rate spreads.
USD/JPY. The yen has risen following the SVB bankruptcy against all major currencies, once again acting as a safe haven. Japan is maintaining its yield curve control regime for the time being, with the Bank of Japan maintaining a 0.5% cap on the 10-year JGB. With inflation in Japan now exceeding the 2% threshold – and nominal wage growth gathering momentum – markets expect the new governor, Mr. Kazou Ueda, to implement a gradual exit from this regime. Thus, we remain Overweight on USD/JPY.
USD Index
Emerging market currencies. Focus must be placed on the Peso and Renminbi this month. Mexico’s Peso has become a desired currency for investors due to Mexico’s geographical proximity to the US, high interest rates and strict fiscal policy. Consequently, the Peso has realised its highest level in over five years, raising 8.5% this year. Comparably, the South African Rand weakened by 7.1% and the Brazilian Real gained by only 2.4%. The 2% rise of the Renminbi relative to the dollar cannot be overlooked. Russia’s decision to adopt the Renminbi as one of its principal currencies for international reserves, overseas trade, and some personal banking services could provide the rationale for this performance.
Commodities may be buoyed by the reopening of China's economy and gold will continue to play its traditional role as a safe haven. Hedge Funds may have lost some of their shine compared to the protective benefits of yield-bearing fixed income products, they remain a core pillar of our diversification strategy.
Commodities. We are maintaining our neutral position on industrial commodities. Industrial commodities have corrected downwards after the SVB bankruptcy and the financial scares it caused. Nevertheless, the continued reopening and expected recovery of the Chinese economy should support industrial commodities.
Gold. Gold prices rallied hard since the collapse of Silicon Valley Bank, surging as much as 10% from its 2023 lows. We expect fears around the stability of the global financial system to linger in the short term, and remain Overweight on gold, which should continue to benefit from its safe haven status in this environment.
Oil and gold prices
Sources: Macrobond, ICE, EIA, 17/03/2023
Infrastructure & specialist property. We hold an allocation to a diversified portfolio of infrastructure (such as energy storage and efficiency, smart grids, waste-to-energy, air treatment and digital infrastructure) and specialist property assets (including care homes and e-commerce and logistics warehouses). These real assets offer additional diversification from other risk assets such as equities, as well as an attractive income stream and reasonable sensitivity to inflation.
Hedge Funds. In unstable market conditions hedge funds can help a portfolio, but selectivity is key. We prefer strategies which hold their own in bear markets, such as Merger Arbitrage, trend followers and Equity long/short. These strategies provide relatively safe, uncorrelated sources of returns from equities. Our hedge funds allocation has performed well over 2022 and have been a great diversifier in our strategies.
Tail Risk Protection Note. Tail risks are typically understood as unlikely but severe crisis events which shock markets and dramatically impact the value of risk assets negatively. The dot-com bust at the turn of the century and the Great Financial Crisis in 2008 and 2009 are examples of such events. Despite conditions not being favourable for it in 2022, we believe the Tail Risk Protection Note offers our portfolios yet another critical source of safety and complements the existing diversifiers.
