March was a positive month for fixed income markets. Spreads on corporate bonds tightened, while yields dropped sharply worldwide. German government bond yields even dipped below 0% for the first time since October 2016. The main reason for these movements was the action taken by the Fed and the ECB, but poorer economic data in the Eurozone did not help either.

At the start of March, the ECB announced that it would keep interest rates low for longer, at least until the end of 2019, and that it would launch new TLTRO loans for banks in September. The new TLTROs will have a maturity of two years and be indexed against the ECB’s interest rate. This announcement came earlier than the market had expected and is a response to the ECB’s lower inflation and growth forecasts. The growth forecast for 2019 was even reduced from 1.7% to 1.1%. Economic indicators in the Eurozone have been worse than expected for several months now. The German PMI, which measures confidence in the German manufacturing sector, stood out in particular last month. It came at its lowest level for the past seven years.

The Fed surprised the market in March by making a significant adjustment to its dot plot at its meeting. This demonstrates that it no longer intends to raise interest rates again in 2019 and that it will cease balance sheet reduction as of September. The growth and inflation forecasts were also adjusted downwards slightly. Yield curves flattened in response to this, and the 3-month versus the 10-year curve even became negative. A negative yield curve is often a precursor of a recession.

German 10-year government bond yields dropped to -0.07% in March, 25 basis points lower than at the end of February. This decrease in yields led to a positive performance for the portfolio. Our underweight in the portfolio’s sensitivity to interest rates versus the benchmark contributed negatively to the portfolio’s relative return. Inflation forecasts fell sharply in the Eurozone in March.
With the exception of Spain, there was a small tightening of spreads versus Germany for all the Eurozone countries. Spanish spreads widened by a few basis points at the end of the month after the country’s rating remained unchanged, while the market had hoped for an upgrade to the rating. The fund profited from the overweights in Slovenia, Portugal, Ireland and Belgium. The underweight in France made a small negative contribution.

The portfolio continues to be positioned for higher bond yields and tighter spreads versus Germany. There is a great deal of uncertainty surrounding the outlook for growth, but leading indicators seem to be bottoming out. A reasonably weak economic scenario has already been priced in to bond yields and ultimately we expect economic growth to recover. The ECB’s announcement on new TLTROs will support tighter spreads, but will also mean that increases in yields will be smaller.