In January, many markets moved in completely the opposite direction from the one in which they moved in December. December was a negative month for the riskier asset classes, while January was a good month for them. Equity prices around the globe rose by 5%-10%. Credit spreads on corporate bonds tightened; by 10 basis points (bps) for investment grade and 60bps for high yield bonds. Commodity prices climbed, led by an increase in oil prices of about 15%. OPEC’s planned production cuts of 1.2 million barrels a day may have played a role here. However, government bond markets did not undergo a reversal, with the most remarkable decrease occurring in US bond yields. In a month in which US inflation forecasts were increased by 10-15bps, 5 and 10-year government bond yields declined by about 6bps. This means a drop in real yields of about 20bps. In the Eurozone, 10-year government bond yields fell by about 15 bps.

One major reason for the lower bond yields and higher equity prices was the more cautious tone being adopted by central banks. Equity markets viewed this as support, as the impression had previously been that the Fed, the US system of central banks, would continue to raise interest rates for too long. In October, the market was still pricing in three interest rate hikes by the Fed in 2019. In January, however, prices even briefly priced in a cut to interest rates. This was understandable. In December, Fed chairman Jay Powell continued to claim that the reduction in the Fed’s balance sheet would happen on automatic pilot and that further step-by-step increments in interest rates were likely. Powell adopted a more nuanced tone in January though. The Fed now intends to be patient on further interest rate hikes and the reduction of the balance sheet will now depend on how economic data evolve. ECB President Draghi was also being cautious at the end of January and pointing to the downward risks in the Eurozone economy. There is very little chance of Draghi raising interest rates again before he relinquishes the post of ECB president later this year.

The economic data reinforced the picture of a weakening economy. There are increasing signs that global economic growth is weakening, particularly in Europe and in China. Examples include the economic recession in Italy, the falling IFO business climate index in Germany and Chinese car sales that in December were down 16% on a year earlier. Indicators that measure the extent to which economic data match the forecasts plunged deep into the red in most regions. Several factors seem to be behind the weakening growth, including a slowdown in growth in China, the uncertainty surrounding the Brexit, the difficult trade relations between the US and China and the impact of monetary tightening.

Differences in yields decreased in the Eurozone in January. Peripheral and soft-core Eurozone countries, such as France and Belgium, saw the difference in yield with Germany shrink. The weakening growth does prompt some fresh concerns about Italy. Italian economic indicators weakened further. Will Italy have to implement further cut-backs in order to compensate for worse-than-expected growth?

German 10-year government bond yields fell further to 0.15% in January, 9bps down on the end of December, and taking the transition to new 10-year government bonds into account the drop was really 15bps. Our underweight in the portfolio’s sensitivity versus the index therefore contributed negatively to the portfolio’s relative return.

Spain, Portugal, Ireland and Belgium saw their spreads versus Germany tighten and the slight overweight position in these countries contributed positively. The underweight in France yielded a slightly negative contribution. Supranational institutions again made a small positive contribution. It is noticeable that the differences in long-term yields for countries such as Italy and France versus Germany barely tightened and in fact were more likely to widen slightly. The market is cautious. We reduced the fund’s position in the peripheral EU countries towards the end of the month. We again added a green bond to the portfolio in January via participation in the new bond issue by SNCF Reseau.

The portfolio continues to be positioned for higher bond yields and smaller differences in yield versus Germany. There is a great deal of uncertainty surrounding the outlook for growth, but we believe that a reasonably weak economic scenario has already been priced in to bond yields and that economic growth will ultimately continue. The opportunities for an economic upturn in the Eurozone are being underestimated. The central banks are providing a boost to higher bond yields by reducing their quantitative easing.