Central bank sentiment
The second quarter of 2017 was marked by central banks’ communication returning as the main driver of performance of financial markets. The US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of Canada (BoC) guided investors towards an intention to normalise their monetary policies by reaffirming their confidence that the current global recovery will bring inflation near their 2% target.
More broadly, the underlying economic picture has remained positive, with Europe in particular surprising on the upside, financial conditions improving and political risks receding following Macron’s victory in the French presidential race. These, combined with disappointing inflation readings early in the quarter, translated into muted performance across fixed income markets, with US treasuries remaining supported and German bunds selling off in the last week of June. However, corporate bonds continued to generate positive excess returns over government bonds and the US dollar suffered from the lack of reform progress by the Trump administration.
US inflation rolling over
In the US, growth eased to 1.4% in the first quarter, mainly on the back of a slowdown in consumption, as is often the case during that time of the year. A more rapid expansion in the investment sector was, however, a positive development after several quarters of disappointing performance. The labour market has remained strong, with the unemployment rate falling to 4.3% in May, its lowest level in 10 years, and average earnings increasing. The Fed followed up on its March hike by delivering another 25bp rate rise at its June meeting. It also announced its intention to reduce the size of its balance sheet and guided towards one further rate hike this year. Investors have been questioning the Fed’s plans in light of the absence of clear inflationary pressures. This has kept US treasuries supported and contributed to a depreciation of the US dollar in the quarter.
European corporates a key overweight
In Europe, positive momentum was confirmed with Eurozone growth coming in at 1.9% (annualised) in the first quarter, its fastest rate in two years. Consumer spending continued to make a strong contribution and investments picked up. Confidence indicators have remained high and were further boosted by Emmanuel Macron winning the presidential elections in France. Anti-establishment political forces are losing ground in Europe, giving way to renewed proposals for further EU integration like those championed by France’s new president. The ECB revised up its growth assessment while also downgrading its inflation outlook. At its June meeting, the ECB announced a change in its policy framework by signalling that it no longer expects interest rates to fall but to stay at current levels for an extended period. This resulted in core government bonds selling off, with the German 10-year bund rising from 0.25% to 0.47% in the last week of June.
Japanese investments picking up
In Japan, growth remained at 0.3% in the first quarter of 2017, confirming the positive growth path of the Japanese economy, which was supported by the pickup in the global economy and the recovery in private domestic activities. Exports continued to increase, with domestic producers meeting strong foreign demand thanks to the upturn in the global cycle. After years of deleveraging and restructuring, Japanese corporates have started investing again as illustrated by the drop in the corporate savings rate. At its April meeting, the Bank of Japan (BoJ) offered its most optimistic assessment of the economy in nine years while maintaining its accommodative monetary policy measures on the back of a still benign inflation backdrop. 10 year Japanese bond yields closed the quarter just below 0.10% and the Yen rose to $113.
Summary & outlook
Overall, performance on government bond markets was mixed during the quarter, with German bunds selling off and US treasuries delivering positive returns. Corporate bonds again outperformed government bonds and were supported in Europe by the ongoing quantitative easing (QE) programme by the ECB and the search by investors for positive-yielding assets. This general contraction in corporate spreads remained the main driver of performance for the CF Canlife Global Bond Fund. The Fund also benefited from the Euro strength triggered by the change of tone at the ECB. On the other hand, the US dollar and Japanese Yen depreciation was detrimental to performance. We have, however, started to see Sterling depreciate since the end of the period. During the quarter, the CF Canlife Global Bond Fund delivered a positive return of 0.45%, compared to the -0.95% loss from the Citi World Government Bond Index.*
For the rest of 2017, we expect to remain in a macro environment featuring improvements in the underlying economic data, with the recovery being supported by expansionary fiscal policies in the US and in Europe. Inflation should also move gradually higher on the back of these reflationary policies and a recovery in commodity prices, which should prompt the Fed to proceed with one additional rate rise by year-end. Uncertainty factors, however, have risen in relation to the composition and implementation of the fiscal reforms proposed by the Trump administration, as well as the future path of monetary policies implemented by central banks. We maintain a short duration positioning at current levels and an overweight allocation to corporate bonds versus government bonds.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
*Source: Performance figures from Morningstar, bid to bid, with net income re-invested for C share class.
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