Helicopter View
After three months of strong rally, bonds took a breather in February. Overall, the bond yields continue to be attractive both on a standalone as well as on a relative value basis.
Figure-1: Attractive yields across fixed income
Inflation slides down albeit at a slower pace
US headline inflation is down from the peak of 9.1% in June’22 and 6.5% in Dec’22 to 6.4% in January 2023, a tad higher than the consensus estimates, but still the lowest reading for YoY (Year-on-Year) headline inflation since October 2021.
Almost half of MoM (month-on-month) inflation was due to Shelter, which, as discussed in previous Monthly Commentaries, lags prevailing rents by 6-8 months. January 2023 marked the eighth straight month in which the annual rent growth slowed, falling by 1.9% from previous month. This is yet to be reflected in CPI shelter measure.
- JPMorgan Asset Management, Feb’23
Figure-2: Fall in market rents not yet reflected in CPI
Labour continues to be strong as expected
The unemployment rate in US hit 53-years low of 3.4%. However, labour market numbers for January are exacerbated due to seasonal adjustments. In the five years before the pandemic, non-seasonally adjusted payroll employment fell by an average of 2.9 million jobs (2.0%) per year between December and January. This January 2023, the decline was just 2.5 million jobs (1.6%), which resulted in reported blockbuster 517k job additions. Over the course of a year, seasonal adjustments net to zero. Hence, one should be careful in extrapolating the job additions.
Figure-3: Non-seasonally adjusted US payroll changes (mn)
Geopolitics remains tail risk
The first anniversary of Russia-Ukraine conflict created belligerent headlines; however, it’s current impact is severely curtailed as energy prices remain low. EU & US continue to provide strong support to Ukraine while discouraging Ukraine from reclaiming Crimea, at the same time Russian military is incapable of making meaningful advancement. Further, China is also pushing for ceasefire.
- Source: Redfin, Feb’23
- Source: ING Research, Feb’23
Higher for Longer: Inflation & Interest Rates
We believe the inflation print shall continue to be elevated due to both fundamental and technical factors. Worker shortages due to ageing population, reduced immigration, onshoring of supply chains, and transition to net-zero emission, would continue to add cost pressure to economy. These would be worsened by technical factors such as increase in weight of Shelter in headline inflation index from 32.9% to 34.4%.
Even if the inflation rises by just 0.2% MoM for the next 12 months, it is unlikely to get back to the Fed’s target of 2%.
Figure-4: Inflation likely to remain elevated
That said, increased interest rates are already damaging the economy: with US Government interest burden increasing by US$ 1 billion per day and reaching $783bn on trailing 12 months basis.
Figure-5: US Govt interest expenses on public debt
- Source: BlackRock, US Census Bureau, Nov’22
- Source: Creative Planning, Feb’23
Further, the new home sales have already dropped by about 25%, a steeper fall vis-à-vis past mega Fed rate hiking cycles of 1970s, 1980s, and mid-2000s.
Figure-6: Fall in new housing sales
The corporate profits are also increasingly under pressure due to incremental interest costs.
As the damage to the economy increases, the economic rationale for Fed rate hike, will give way to politics of rate hike curtailing significantly higher peak Fed rate (as mentioned in our October 2022 Monthly Commentary). Having said that, the market is now pricing peak Fed rate of circa 5.4% as against circa 4.9% at Jan’23 end. Thus, providing juicy bond yields for investors in high quality short duration.
Takeaway: Attractive income in bonds
The prevailing bond yields are most reliable indicator of investor returns. Hence, current elevated yields provide excellent opportunity to add bonds, more so because, it is one of the rare times that the US is entering into downturn with strong trio: household, corporate and bank balance sheets, as detailed in our earlier Monthly Commentaries.
Figure-7: Higher yields indicate higher investor returns
Our flagship Silverdale Bond Fund (SBF) continues to be positioned to take advantage of the high carry offered by quality bonds, with 76% high quality Investment Grade bonds and a duration of 1.66 years; yet, having high leveraged YTM of 13.8%, pointing towards higher potential returns to investors.
- Source: BlackRock, US Census Bureau, Nov’22
- Source: Bloomberg, Silverdale, Guggenheim, Dec’22
We thank you for your trust in Team Silverdale.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR FEBRUARY 2023. This document is written for the benefit of and is being communicated exclusively to Accredited Investors or Institutional Investors as defined under the Securities and Futures Act (Cap. 289) of Singapore. The above commentary does not provide a complete analysis of every material fact regarding the market, industry, security, portfolio or any Silverdale fund. It is not a recommendation to buy or sell any security nor an investment advice. The portfolio holdings, opinions and information may change without notice and the actual results may differ from the said opinions and estimates. The contents of this document, including any narrative, does not constitute an offer to sell or a solicitation of any offer to buy the units or any Sub-Fund or class of the Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational purpose only. The distribution of the shares of the Fund may be restricted in certain jurisdictions. It is the responsibility of the person or persons in possession of this communication to inform themselves of, and to observe all such restrictions, all applicable laws and regulations of the relevant jurisdiction, including of any applicable legal requirements, exchange control regulations and taxes in the countries of their respective citizenship, residence and domicile. Any subscription for units or shares must be made solely based on the Fund’s private placement memorandum, applicable class supplement) and Subscription Documents (together “the Offering Documents”). Past performance is not an indicator of future performance. The Fund uses leverage and invests in financial derivative instruments. Please refer to the Offering Documents for Risk Factors. Nothing in this document is intended to constitute legal, tax, securities or investment advice or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please seek opinion from independent professional adviser before taking any decision based on this document.