Yet again there were no clues in the FOMC minutes as to when the Fed will raise rates, however most officials “judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point”. The more dovish sentiment saw many market makers revise their expectations for September lift-off, with some pushing theirs out as far as February 2016. As a result, US Treasuries rallied and the dollar fell; the benchmark two-year fell 6 basis points, while the ten-year closed 7 basis points lower at 2.126%, and the curve has continued to flatten today.
Although job creation has been strengthening, wage growth has not shown any signs of accelerating, thus stubbornly low inflation remains a concern for the committee. Since the meeting was held at the end of July, Brent crude has plummeted ~13% and WTI is down ~18%, adding further downward pressure on inflation. The PCE deflator reading in June has only risen 0.3% year-on-year and CPI, released yesterday, continues to languish. However, our central view is that the Fed needs to get off of zero rates by at least one but probably two 25 basis point moves to defend home grown criticism before sitting back and awaiting further economic evidence regarding the global economy.
Keeping with oil, as longer term bond fund managers we try to mitigate shorter term risk through our investment process and by investing in value positions. Whilst we are exposed to the energy and commodity sectors, every position held is in Wealthy Nations as defined by our NFA analysis with over 65% of our holdings represented by government or quasi-government issues by those nations. Through this we endeavour to alleviate the biggest risk in times of sectoral volatility, balance sheet erosion, such as we are seeing in the energy/commodity sectors at the moment.
As our holdings are government owned or indeed the government has a major stake/interest in the companies we lend to, we can take an additional layer of comfort from that involvement; looking to the government balance sheet rather than a more fragile corporate one. This is the first stage in trying to reduce the downside risk of any sectoral crowding in our investments. The next step is to only invest in value positions which are identified by our Relative Value Model, this enables us to create a portfolio with added credit/spread cushion; currently around 265 basis points over US Treasuries for a weighted A3 rated portfolio. As we only focus on hard currency bonds, the portfolio is made up of US dollar denominated bonds and some sterling bonds - which are hedged into the dollar - thus reducing the volatility experienced by other funds, which are exposed to the likes to the Brazilian real and Turkish lira; down ~24% and ~22% so far this year.