The Taper – that wasn’t
Yesterday proved to be a landmark day in Federal Reserve policy making. The two day FOMC meeting concluded with the announcement that no tapering of QE would occur. The minutes cited evidence that structural unemployment problems remain within the US economy, particularly with regard to the wide unemployment measure, U6 unemployment. Also highlighted was the fact that the recent fall in headline unemployment rate to 7.3% was largely due to a reduction in Labor Force Participation which, at 63.2%, is running at a 35 year low. The other key aspect of the Federal Reserve mandate, price stability, also shows that inflation is well below their target of 2%. Monetary policy decisions that go against market consensus rarely occur in the current environment and, whilst there was a clear split between the economists forecasting tapering and those that did not (68.75% of economists polled by Bloomberg predicted a median of $5Bill tapering in US Treasury purchases), the announcement of “no tapering” was met by sharply declining bond yields across the world.
Just 10 business days ago, the US ten-year Treasury yielded in excess of 3.00%, the same bond yielded 2.69% at its close last night:-
As one would expect, risk markets reacted positively to the news, with the S&P500 rising an impressive 1.24%, to close at 1725, 5.2% higher than the level seen on 6th September 2013. Credit markets also followed suit, with the synthetic CDX Investment grade spread falling 4bps.
There is no doubt that the past few months have been difficult times for fixed income investors, with the rate of appreciation in bond yields only matched by the notorious bear market of 1994. The Federal Reserve have sent out a clear message that, contrary to what many commentators would have us believe in sensationalist news articles, the bond markets remain an extremely important asset class within a well-diversified portfolio.
In recent meetings and conference calls we have long pointed out that taking binary bets on a market outcome was not our preferred route within the City Financial Strategic Global Bond Fund. Instead, we have concentrated our investments into assets which exhibit a strong diversification in correlations to protect against the recent volatility. Last week we increased the Fund duration from its lowest level since it was re-launched on 1st January 2012, of 1.7 years, to its current level of 2.2 years. We also maintained exposure in high quality corporate bond issues with the credit exposure in the Fund standing at 57%, 9% of which we consider to be “high beta” positions including subordinated financial paper and utility hybrids.
The City Financial Strategic Global Bond Fund aim of providing a solid “building block” within a diversified fixed income allocation is being met and, as we have indicated on many occasions, it allows portfolio managers to allocate to other fixed income assets classes, such as high yield, with comfort. In a highly volatile asset class, the Fund continues to exhibit low volatility (currently measuring just 1.3%, 30 day annualised).
Graham Glass MCSI
Head of Fixed Income, City Financial Investment Company
All data figures source Bloomberg as at 18/09/13