Yield markets experienced their most significant movement on 20 July, prompted by speculation in the market that the Bank of Japan was considering a change to its monetary policy. This triggered the largest increase in Japanese bond yields of the past two years. It also pushed up yields in the rest of the world. The Bank of Japan was subsequently forced to spend a large amount buying bonds in order to prevent further increases. Ultimately, the Japanese central bank made few alterations to its monetary policy at the end of July. However, it did announce that it would be more flexible in its bond buying and that it would permit Japanese 10-year bond yields to move within a broader range.

The trade war continued to play a major role in July. One positive result for the market came from the trade agreements made between Trump and Juncker, which came as a surprise. While they do not mean an end to the trade war, they are definitely a step in the right direction and will have a positive impact on economic sentiment in the Eurozone. The relationship between the US and China has not improved, however. Trump threatened to raise import tariffs on USD200 billion in Chinese goods, to which China responded with import tariffs on USD60 billion in US products.

In spite of the trade war, the US economy remains robust: it grew by 4.1% over the second quarter and other indicators continue to be positive. Consumers are optimistic about the future, the retail sector grew by 6.6% and the job market remains strong. The Eurozone economy looks to be weakening slightly. Economic growth over the second quarter was slightly worse than expected at 2.1%. Leading indicators do point to some stabilisation, however. Inflation figures were up slightly, with headline inflation increasing to 2.1% and core inflation to 1.1%.

As expected, the ECB made no changes to interest rates or its bond-buying programme at its July meeting. It confirmed that the bond-buying programme would be halved to EUR15 billion a month in October and halted completely as of December. Draghi did not wish to say much about the timing of the first interest rate increase, nor was any further clarity given on reinvestments.

There was relief in early July when Merkel reached a deal with the CSU on German immigration policy. During the preceding weeks, speculation was rife that it could herald the end of her fourth government. Some measure of calm has now returned to German politics.

German 10-year government bond yields rose by 14 basis points in July, partly triggered by speculation about the Japanese central bank’s monetary policy. The entire yield curve displayed a similar movement. Our underweight in the portfolio’s sensitivity to interest rates compared to the index contributed positively to the relative performance. Inflation-linked bonds performed slightly worse than nominals, mainly due to the lower oil price.

The differences in yields versus Germany shrank for all the Eurozone countries in July. In particular spreads on Spain, Slovenia and Portugal tightened, although spreads are currently nowhere near the lowest levels seen this year.

The position in government-related paper displayed a positive attribution as they outperformed government bonds. Government-related paper shows a strong correlation to swap spreads. Swap yields increased less sharply than bond yields, which led to a tighter swap spread.

The portfolio is positioned for higher bond yields and smaller differences in yields versus Germany. The Italian political situation has calmed down somewhat now and this allows for smaller spreads on government-related paper and peripheral EU government bonds. The sound economic data and gradual withdrawal of central banks continue to provide a boost for higher yields. Our focus will continue to be on the political situation in the Eurozone and the impact of the reduction in the ECB’s bond-buying programme.