October was dominated by a return to volatility on the financial markets. Equities noted their sharpest fall since May 2012 and bond yields came down around the world, with the exception of US bond yields. The main reasons were the political situation in Italy and the burgeoning trade war between China and the US, although the higher bond yields in the US also caused unease. The higher bond yields in the US can be attributed to comments by Powell at the start of October - he said the Fed might have to raise interest rates more aggressively – and to robust macro-economic indicators.

The global economy continues to perform well, but there are large regional differences. Data continue to be positive in the US. Unemployment is at its lowest level for 50 years, growth over the third quarter was 3.5% (q-o-q, annualised) and consumer confidence remains high. GDP data confirmed the picture of an economic slowdown in the Eurozone. In the third quarter, quarter-on-quarter growth stood at 0.2%, with the Italian economy not growing at all. Leading indicators also show a further deterioration in economic sentiment.

As expected, the ECB made no changes to its monetary policy in October. It still anticipates terminating its bond-buying programme at the end of the year and leaving interest rates as they are until at least after the summer of 2019. Draghi admitted that the data were weaker than expected, but that they remain consistent with a broad-based recovery.

The European Commission rejected the Italian government’s budget proposal on 23 October and has asked Italy to present a new proposal. Italian spreads again widened sharply in the wake of this news, but the decisions of the rating agencies did provide some relief. Moody’s cut its rating to BBB- with a stable outlook, while S&P only cut its outlook from stable to negative.

German 10-year government bond yields fell by 8 basis points to 0.39%, and the German yield curve showed little movement in October. Our underweight in the portfolio’s interest rate sensitivity against the index contributed negatively to the relative performance.

The differences in yield between German and other countries in the Eurozone widened in October, chiefly due to the turbulence surrounding Italy’s budget. The spread on Italian 10-year government bond yields widened by nearly 40 basis points. Other peripheral EU countries followed suit, although their spreads widened less sharply. Our overweight in peripheral EU government bonds contributed negatively to the relative performance.

The fund’s position in government-related paper also displayed a negative attribution as it underperformed German government bonds. Government-related paper displays a strong correlation to swap spreads, the difference in yield between German government bonds and swaps in comparable durations. The negative sentiment on all risk-bearing investments caused swap yields to fall less sharply than safe government bonds, which led to wider swap spreads.

The portfolio continues to be positioned for higher bond yields and smaller differences in yield versus Germany. We further reduced our duration position this month. Economic data continue to be satisfactory, and withdrawing central banks provide a boost for higher yields. For the next couple of months, our focus will continue to be on the political situation within the Eurozone and the impact of the reduction to the ECB’s bond-buying programme.