Short Rates:

USA
The last macroeconomic figures were surprisingly low and the absence of clear direction from the Federal Reserve, with the exception of the announcement of the gradual end to the programmes, meant that renewed expectations of a rise in Fed Funds Rates were therefore distinctly toned down. The return on the 2-year rate, on which we focused last month, has therefore naturally returned to its level of 1%. We estimate that today there is insufficient visibility around the end of the crisis in general and particularly the return of inflation to begin to anticipate a rise in Fed Funds Rates. We are therefore maintaining our forecast of stability unchanged at current levels.

Euro zone
It is fortunate that the unlimited loan was granted for one year, because it was not at the last meeting of the Central Bank that it was announced. Three things will be remembered: confirmation of the status quo at 1%, the policy of "Quantitative Easing" has been implemented tentatively and Jean-Claude Trichet demonstrated a certain air of equanimity with regard to inflation in the Eurozone. The one-year loan, announced several months ago, was widely expected and was a clear success in more than one respect with more than 1,100 participants, €442 billion allocated and an Eonia rate that fell below 0.5%. On the money front, expectations were also down, anchored in a vision that we have shared for several months of the refi rate remaining at its current level.

Long rates:

Between 8 June and 8 July interest rates eased distinctly on both sides of the Atlantic with some sudden movements mirroring the return on the 10-year American rate that “rebounded” by 4% only to fall below 3.30% again at the end of the period. Rather than a single major event, it was an accumulation of catalysts that created quite a buoyant environment for yields. Among these elements, several deserve a mention.

The lull in government issues was certainly an important positive technical factor, given the pressure that these issues brought to bear on the upward trend during the first months of the year. The second ingredient was the return of risk aversion with a rise in volatility in the equities markets as well as markets that ceased to climb in anticipation of a results season with announcements that could be less encouraging than expected. We must not forget the corrective force arising from fundamentals that reflected employment figures announced mid-period, that were far worse than expected, which contributed to the rally in the bond market. Finally, the announcements from the Central Banks also contributed to the rally as well as the reduction in inflationary concerns.

We estimate that this environment could continue for a good part of the summer. We are therefore maintaining the portfolios oversensitive to rates in anticipation of a continued drop in yields.

The curves steepened suddenly during the first days of June, mirroring the 10-2-year French curve which dropped by 0.60% in 4 days before picking up again with a slight rise. We estimate that there is still great potential for the curves to flatten out. We are therefore maintaining the portfolios overweighted on the intermediate and long segments, to the detriment of the short segments. The 2-year yield, for example, in our opinion no longer holds much potential for appreciation at current levels (1.20% for the German yield) and in an environment of a long-lasting status quo on the part of the Central Banks.

Credit:

And just look at this – three, yes three months of outperformance by the credit market since the rally in mid-March. The market dynamic weakened with the recent good performance of government issues but the outlook at the half-year point is very much in favour of credit bonds, which have advanced more than 5%. The macroeconomic environment, the coming peak in rates of default and the impact of the crisis on company accounts, the full effects of which have not yet been fully seen, all continue to favour a prudent strategic vision. On the other hand, some new elements are arising which may delay this vision even though we do not discount a correction involving a temporary re-widening of spreads. The peak in default rates is certainly still to come but it is within sight; the general agreement is that it is anticipated for the first half of 2010. This is rather reassuring as the markets often have a tendency to anticipate events. The significant amounts of debt issued and the large numbers of capital increases give flexibility to issuers and reduce fears around their liquidity. This is to the detriment of the balance sheets, but overall it was a sound approach at the beginning of the crisis. Finally, the crisis dynamic has settled at levels which are certainly very low but which enable the markets to begin to anticipate a trend towards recovery (particularly in the US), reflecting the progression in leading indicators published over several months. The amount of primary issues, which hit a record high over the half-year period, has slowed down, but the pursuit of yields and the demand for securities is still very significant in an environment of low interest rates. All these elements lead us to maintain in our portfolios credit allocations that are in line with their indices.

Inflation-indexed bonds:

The underperformance of inflation-indexed bonds in relation to nominal bonds during June marks a break in the trend after 3 months of significant outperformance. The return to risk aversion, the publication of surprisingly low inflation figures and communications from the central banks are all factors which can explain this underperformance. We have taken profits and reduced our exposures over the last month; the potential return of offerings in this asset class and the seasonality which is less buoyant reassure us in this position.

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Groupama Asset Management takes no responsibility for information that may be incorrect.
Past performances are not indicators of future results.