The Daily Update - Fed, spreads, portfolio positions

The summer markets are still with us as focus moves on to Friday's US non-farm payroll (NFP) release; now that Janet Yellen’s Jackson Hole testimony is behind us. Following her comments at the back-end of last week, the market is divided on the timing of the next Fed rate hike. The probability of a hike at the next meeting on September 21st has risen from almost zero following the Brexit vote to 36% today, down from 42% on Friday afternoon following, what some might call, more hawkish comments from the Fed chair. In the run up to Friday’s NFP data a further 5 Fed members are speaking which could add some volatility in the summer time’s less liquid market.

The UST market is already pricing in the chance of September move with 5-year yields up 15bps since the end of July, the 10-year up 11bps and the long bond 3bps higher. Regular readers will know that we remain positioned with a longer duration compared with our peer group of managers and we  maintain a strong bias towards higher rated names as we see a continuation of a flattening of the UST curve regardless of when the Fed tightens. However, the general view at Stratton Street is the sooner the Fed hike, the better. We have seen signs of inflation edging higher in certain measures and so a pre-emptive Fed would reduce some market concerns that it is falling behind the curve.

After the positive performance of our funds over recent months we are regularly asked what we expect in regard to performance over the remainder of the year. As our positioning suggests, we remain positive for longer dated credit and view US dollar bonds as a high yielder given the other major markets appear to offer little to negative yield currently. Our credit positions still offer us an average spread around 200bps over USTs with our portfolios sitting at a weighted average 2.3 credit notch cushion against where our Relative Value Model (RVM) indicates fair value to be. This is as mentioned above for assets which are very highly rated; our portfolios have a weighted credit rating between A2/A3 which again offers us plenty of scope to move down the credit curve when/if the opportunity arrives to take on further credit risk.

We currently view spreads as neither cheap nor expensive but we feel our stance in both duration and credit is the optimal position given the risk reward characteristics of our investment process. We therefore believe that there are still gains to be had in this world of where yields for our holdings continuing to fall as we enter, probably, a period of much lower yields than previously perceived. Any volatility offers a good opportunity to add to positions, however we are not looking to change our overall strategy any time soon regardless of whether the Fed tighten or indeed wait.