Madame Lagarde freezes the markets at the end of the year…
With the winter break fast approaching, investors yesterday looked forward to the 2022 deadline that will mark the history of financial markets: the ECB meeting, followed by Madame Lagarde’s speech. For several weeks, markets seemed to have stabilized, and a series of statistics reassured them and drove rates lower (and therefore bond markets higher): at the start of last week, the US inflation number was a weak 0.1 point. led to a tightening of ten-year interest rates in Europe by more than 10 basis points in a matter of minutes… If the economic decoupling between the Eurozone and the US has been going well for more than a decade, the latter remains. firmly anchored to the former from a monetary and financial point of view, and European markets often remain a derivative of American markets… Can we find a relationship between a tenth of a point of inflation in a country in the United States? full of oil, full employment and technology companies could provide decades of growth and long-term viability for the Italian state, whose political turmoil, abysmal budget deficit and its aging economic structure are among the most energy-imported countries in the world (in 2020, 2 and the 4th importer of gas)
So sovereign yields have quietly slipped lower since their October peak, with corporates offering their bond portfolios a marked boost in performance to reassure investors for year-end…
However, over the past few weeks, we’ve noticed a few things that call for some caution:
- A technical phenomenon of “short payments” on end-of-year rates, which creates temporary sharp spikes but is likely to continue into the beginning of the year
- Persistence of inflation and price or wage increases announced by certain companies or institutions and not yet recorded in statistics
- A completely different situation in the Eurozone compared to the United States, which leads all financial markets
- An ECB delay on the Fed could unnerve markets
- For example, long rates in the Eurozone are still very low, with the 10-year Bund 25 basis points below the ECB rate and almost 100 basis points below the ECB’s 2023 target…
So, taking advantage of this renewed performance in our portfolio, we sold several long positions and reduced the duration in our flexible portfolio to 2.5 versus 3.5 at the end of November. Well done to us yesterday when we heard Madame Lagarde give a market-chilling speech that only the Snow Queen could do in her time! Three important points:
- The ECB sees core inflation still above 4% at the end of 2023, twice its target, despite already planned rate hikes of 75-100bps for the year. raised rates more and for longer than the market had expected so far.
- The reduction in the balance sheet, expected from the second half of 2023 until now, will finally take place in the first quarter, with a capped amount of €15 billion per month, increasing significantly from the second quarter. This reduction in the balance sheet will be in addition to the reductions already made by offsets related to the bank’s TLTRO program, which has already begun this year. So beware of the bonds that add the most to the ECB’s balance sheet, such as corporate and peripheral debt, led by Italy…
- The ECB’s “terminal” rate therefore looks 4% higher than the 3% expected so far… Assuming the entire curve shifts 1%, this could lead to massive valuation declines in the coming weeks, with the 5-year rate almost 4 points, and the 10-year interest rate will fall by 8-10 points… Already yesterday, 10-year sovereign bonds lost between 2% and 3%… If bonds could look long. their fall has been halted by strong recession fears after significant rate hikes by the ECB in the coming months, we will have to worry more in the intermediate segment and carefully monitor whether its carry cushion is sufficient to support such gaps.
Therefore, we reiterate our very corporate positioning at the end of the year with a fairly short, high yield and high yield premium.
Unfortunately, the end of the year promises to be less peaceful than we’d hoped after an already difficult year for all investors, with confirmation from the ECB that they are on track for tighter policy and higher interest rates for 2023. several deployment directions:
- corporate preference for sovereigns with the advantage of a strong yield cushion that is less sensitive to rate uncertainty (high yield)
- great flexibility in duration with the ability to hedge the interest rate of the portfolio
- Interest on US exchange rate positions
- interest on bank bonds that benefit from a high interest rate environment, especially hybrids that benefit from high turnover and often reset coupons between 3 and 5 years.
- Precautions against issuers that are heavily dependent on financing, such as utilities, telecommunications, property companies
- Caution against overly cyclical issuers in a context of strong central bank constraints coupled with sharp increases in consumer prices
- Precautions on peripheral sovereign debt
If these broad outlines are a summary of our guidance guidance for the coming weeks, which we have already launched ahead of this famous ECB meeting, we invite you to share our more detailed views on the market and our bond portfolio. 10 over lunch at the Automobile Club De France or by webinar (register here).