The Weekly Update

After the positive performance of our funds over recent months we are regularly asked what we expect in regard performance over the remainder of the year. As our positioning suggests we remain positive for longer dated investment and see US dollar bonds as a high yielder given the other major markets appear to offer little or no yield at all. Our credit positions still offer us an average spread of somewhere around 200 bps over the UST curve with our portfolios sitting with investments around 2.3 credit notches cheap, on average, 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 in the A2 bracket which again offers us plenty of scope to move down the credit curve when/if the opportunity arrives to take on further credit risk.

Currently, in our view, spreads are 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. Therefore we believe that there are still gains to be had in this world of high liquidity and cash rich investors with yields for our holdings continuing to fall as we likely enter a period of much lower yields than previously perceived. Any pickup in volatility offers a good opportunity to add to positions and we feel that little will change over the near term should the Fed decide to hike or not at the next meeting.

August is a notorious month for the market overestimating the rate of jobs growth with the miss ranging from 11,000 to 88,000 over the past five years; yet again this has proved to be the case on Friday with 151,000 jobs added against expectations of 180,000 jobs added.  The strong July figure was revised up from 255,000 to 275,000 jobs and the two month revision came in at - 1,000.  The unemployment rate was unchanged from the previous month at 4.9 percent and the participation rate was unchanged at 62.8 percent.  The average hourly earnings came in at 2.4 percent yoy, slightly below expectations and the prior month.  Average hours worked edged lower to 34.3 a low since February 2014.

Ahead of the release the futures were looking for a 34 percent chance of a hike in September this year and a 59.8 percent probability of a hike by the end of the year. The market seems to have taken little notice of the 150k number, with probabilities for a rate hike in September still around 32% and 60% for December.

However, the issue is what level of job growth the Fed would now view as continuing to show an improving labour market in terms of its dual mandate maximum sustainable employment and an inflation rate of 2 percent.  Stanley Fischer, the Fed Vice Chairman, stated in his 21 August Aspen speech; “So far in 2016, nonfarm payroll gains have averaged about 185,000 per month--down from last year's pace of 230,000, but still more than enough to represent a continued improvement in labor market conditions. Estimates of monthly job gains needed to keep the unemployment rate steady range widely, from around 75,000 per month to 150,000 per month, depending on what happens to labor force participation among other things.” The Fed’s Lacker also added that there was a material increase in risk regarding waiting too long to hike rates.

Also last week The World Bank issued the first ever Special Drawing Rights (SDR) bond via the China Interbank Bond Market (CIBM). The AAA rated 3-year SDR 500m (USD 700m) note underwritten by the International Bank for Reconstruction and Development (IBRD) will settle in renminbi (RMB) on September 2.

Initial price guidance was set at a yield of 0.4-0.7%, so more attractive than the likes of AAA rated 3-year Bunds yielding negative 0.65%. Using our proprietary Relative Value Model and workings using the SDR currency weightings, in terms of “fair value” the initial yield guidance at the high-end of 0.7% looked about right. As it was the first SDR bond to be issued in over 35 years, demand outstripped supply and the bond was issued at only 0.49%; well below the yield offered by similar IBRD bonds issued in RMB. For example, the RMB 3.48% 2018 issue, also rated AAA, is currently trading at a yield above 3%. Despite the lower yield, the People’s Bank of China (PBoC) say the issue was almost 2.5 times oversubscribed.

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