What a difference a month can make. Events in the Persian Gulf have driven the price of oil above $100 per barrel, resulting in bond yields rising globally amid fears of energy-driven inflation. Coupon income offset some of the losses attributable to rising yields; however, most major bond indices fell in March. The Bloomberg U.S. Corporate Total Return Unhedged Index declined by 0.54%, while the shorter-duration (and less interest rate-sensitive) Bloomberg U.S. Intermediate Credit Index fell by 0.17%. As one might expect, given Europe’s higher sensitivity to Gulf-derived energy, European credit underperformed its U.S. counterparts, with the Bloomberg Euro Corporate Total Return Index falling by 1.0% in March.
At the same time, the spectre of inflation has led markets to dramatically revise their expectations for central bank policy. Investors now anticipate that the Federal Reserve will deliver no rate cuts for the remainder of the year (compared with expectations of two cuts at the end of February). In parallel, both the Bank of England and the European Central Bank are now expected to deliver two interest rate hikes, a notable shift from earlier expectations of easing.
Despite the significant market movements, central bank expectations shifted by a similar magnitude and in the same direction, meaning that hedging costs (which are driven by interest rate differentials) remained relatively stable throughout March. The annualised three-month hedging cost of U.S. dollar returns into euros was 1.63% at the end of March, down from 1.7% in February. Swiss franc hedging rates edged marginally higher, rising to 3.91% in March from 3.83% the previous month. Provided rate expectations do not diverge, the narrowing of base rates between the eurozone and the U.S. should result in lower hedging costs as the year progresses.
The careful credit selection within the iMGP U.S. Core Plus Fund has resulted in a portfolio generating yields in line with the U.S. Corporate Index, but at almost half the duration. With absolute yields now above 5%, we believe the fund represents an attractive opportunity. For European investors, the continued decline in hedging rates adds to the appeal of the asset class, which offers both diversification benefits and attractive levels of yield.
