Some factors suggest the euro will now stay firm vs dollar
Quaero Capital’s yield opportunities strategy benefitted from exposure to some European assets over the past month. Exposure to European construction, to French and Italian banks, and to emerging discretionary was a positive factor, while the auto sector impact, in particular, proved negative.
European bank perpetuals had a strong performance, while long UK gilts, medium and long sovereigns in CNH, Brazil and Indonesia sovereigns also registered price increases on top of their substantial carry, the manager noted. However, the strength of deflationary forces at play in developed countries has been underestimated.
In the US, the new economy is creating jobs, but these make for low wage pressure because most of the value created resides in the company offering new, instant services to consumers. Until recently, a strong dollar also has been weighing on imported prices. Meanwhile, US industrial production registered negative growth this year, a striking contrast with current European industrial acceleration.
Lastly, the US Government has shown a weak capacity to implement its programs, and hopes for economic stimulus initiatives have now faded.
These cumulative factors drove markets to sell the dollar, and foreign investors reduced their US bond holdings on the way to exit. By mid July, the strategy’s exposure to the dollar was reduced to zero. Hedging of CNH bonds was cancelled. Allocation to short and medium duration emerging sovereign bonds was increased.
These factors suggest the Euro will now stay firm against the dollar. It is early to estimate the extent of this new trend, but a few consequences can be expected for economic perspectives and for markets.
The other significant change for the strategy concerns the yuan, as China’s monetary policy now favours a stable currency, alongside ongoing restrictions on corporate capital outflows.
Overall, equity positions have contributed positively.
In recent weeks, holdings of European exporters were reduced, while European construction and banks were increased. Risk assets prices are now positively oriented for most markets for the immediate future, and allocation to equities is back to maximum.
The strategy invests in assets with attractive risk-adjusted yields across asset classes on a worldwide basis, and aims to achieve consistent risk-adjusted returns with low volatility over the long term. Using a macro overlay, the manager selects undervalued yield opportunities currently subject to concurring positive macroeconomic changes.
Portfolios are the result of individual opportunity selections and are not constructed by reference to any benchmark. The manager applies a rigorous capital allocation and risk control by monitoring overall exposure to FX, rate and credit spread.
Edouard de L’Espée is fund manager at Quaero Capital