The Daily Update - NFP, Renminbi bond fund, currency overlay

Time does fly ‘when you’re having fun’, as we await yet another US Non-Farm Payrolls (NFP) release, and yes it really is the start of June. Market calls today are for a increase of 182k jobs with a stable 4.4% unemployment rate and just 0.2% gain in average earnings which equates to 2.6% y-o-y. However, May data has a history of being well away from the calls due to unexplainable calendar influences.

So while we await the data, we thought we would run through some of our activities this week in the forex market, specifically the Chinese renminbi. By way of an introduction we manage the longest running Renminbi bond fund, which is in an offshore PCC structure in Guernsey, C.I.. We also have the same strategy in a Luxembourg UCITS structure although this has been in place for nearly 4 years rather than the 10 years in November for the offshore fund. (Could be we are quite well positioned for Brexit as all our funds are either C.I. based PCC's or Lux UCITS).

So the strategy of the two funds is indeed to buy value bonds, mainly in US dollars, sterling and euro’s, all hedged into US dollars, we then overlay the entire portfolio, 100%, with renminbi exposure through the foreign exchange market, using either the Chinese onshore currency known as CNY or the offshore currency, CNH. We can use both at the same time if that fits our view to obtain our exposure. Currently we are in the offshore currency CNH 100%.

So this week there have been incredible funding pressures in the CNH arena with short rates hitting 42.815% in HIBOR, the Hong Kong equivalent to LIBOR, on Thursday. As these rates are higher than US rates we get paid to buy and own the renminbi forward - the amount fluctuates with interest rate movements. That’s not to say you get paid 42% for the month but it does effect further along the yield curve. So we have been actively managing the term of our renminbi overlay extending; in total 75% of our overlay, out along the curve selling our shorter dated positions and buying longer term positions, out to 45 days, to lock in this funding pressure. Broadly, we did this in three steps trading for both funds locking in a pick-up of between 4.6% and 5.1% annualised for the term of our position.

This active management adds to the portfolio’s overall return; we would expect maybe four such periods of funding pressure a year, this episode is the second this year as we did activate the overlay management back in March in similar circumstances, and is an additional source of alpha adding ~1% per annum; another unique element of our Renminbi Bond Fund strategy.

From the beginning of the year to today the CNH has appreciated 2.10% against the US dollar but the carry has added an additional 2.76% making a return of 4.86% thus far this year from buying the renminbi. Added to our bond returns, we are currently up over 9.5% for the strategy this year.

By way of a note we do tend to keep our overlay rather short, in the one or two month period, as further out along the curve is rather more volatile and we look for this type of management to enhance our bond performance not to be adding volatility to the overall strategy.

FIREWORKS, drum roll,

Non-Farm Payrolls came in at +138K and a net revision over the last two months of -66K, bad headline numbers for economic bulls, with the unemployment rate at 4.3%, due to the participation rate dropping to 62.7% from 62.9%, and average hourly earnings were released at 0.2% equating to 2.5% yoy; so a much weaker report than expected.

As mentioned above May is one of the months when ‘one just does not know’. Bond yields have fallen on the release, -3.5bps on the 10-year UST’s, as we write, but we feel that we may see a little repositioning, profit taking, into the weekend as we are close to 6 month lows for yields, and no doubt other factors will come to light that offer a different perspective on this data, such as the Fed of San Fran’s payroll–weather model and the government hiring freeze implications which was lifted by President Trump, but that may have swung the report.

We think the Fed will still tighten in June, this is not enough to derail them, but this does question the future outlook, as the Fed, have both the funds rate and balance sheet situation to contend with; too much activity on either or both could be recessionary.