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The second quarter of 2015 was a reporting period rich with global macro activity, but practically every single economic development was lost to Greek debt default headlines. The prospect for a Greek default was the single overriding factor that shaped global equity, bond and currency valuations. Risk premiums across the European peripheral complex were re-priced to reflect the increasingly deteriorating outlook in Greece. Foreign exchange markets were particularly volatile in the second quarter, but much of that variance was fueled by the Greek crisis. Remarkably, despite the concern brewing in Europe, the euro posted a 3.77% gain against the U.S. dollar.
Economic activity in Japan remained fairly balanced during the reporting period. Japanese GDP registered a formidable pickup, while inflation remained tepid. Meanwhile, the central bank (BOJ) upgraded its assessment on the economy and appeared less eager to further loosen monetary objectives. There was also growing evidence from the BOJ that its support for a weaker yen was nearing exhaustion. BOJ Governor Haruhiko Kuroda indicated that “the yen is unlikely to weaken further in real effective terms.” The former comment added to a chorus of Japanese officials who appeared to be reevaluating the scope for further yen weakness.
We have long maintained the economic headwinds facing the dollar-bloc economies of Australia, New Zealand and Canada to be both externally and domestically oriented. The second quarter of 2015 clearly demonstrated how both macro and local factors continued to conspire against these three economies. Depressed West Texas Intermediate (WTI) crude oil prices and waning Chinese growth took their toll on this commodity-sensitive trio. In a surprise move, the New Zealand central bank (RBNZ) reversed monetary bias during the reporting period and cut key rates by 0.25%. As a direct consequence, the New Zealand dollar was the worst-performing currency in the G10, forfeiting 9.44% to the U.S. dollar.
Initially, the transmission mechanisms of European quantitative easing (QE) seemed to reap some early victories. The European Central Bank’s (ECB) 1.1 trillion-euro QE program pushed yields on German bonds, with a maturity of up to nine years, below zero, and also propelled European equity markets to near record highs.
Notwithstanding Greece, economic activity in the rest of Europe was fairly promising. Sentiment in the periphery continued to improve, with robust readings in most Purchasing Managers Indexes. Gross domestic product (GDP) data confirmed that euro-area growth was increasing; rising to a quarterly rate of 0.4%. However, while economic activity continued to improve throughout the period, peripheral bond markets took a turn for the worse as the quarter drew to a close. It soon became evident that Greece was headed into an impasse with its creditors; market repercussions were nearly unavoidable at this point. By the end of the reporting period, many peripheral spreads had widened well beyond the point where the ECB initiated QE. Despite severe declines in both European bond and equity markets, the euro fared remarkably well and managed to appreciate against the bulk of the G20 community.
U.K. and the Nordic Economies:
Early in the reporting period, U.K. economic momentum appeared to have succumbed to the downturn in Europe. U.K. retail sales unexpectedly fell in May. GDP estimates showed growth slowing to 0.3% quarter-over-quarter; wildly missing most forecasts. Making matters worse, Britain’s headline inflation fell under 0% for the time in nearly 50 years. However, the U.K. general elections produced a majority Conservative government for the first time since 1992. This was a major surprise as all the polls prior to the election had suggested some form of a minority lead government. With election risks resolved favorably, overall economic data began to take a turn for the better by mid-period. Nowhere else were these statistics more robust than in the labor markets; private sector wages continued to increase at their fastest pace since 2008. A more hawkish Monetary Policy Committee (MPC) directly contributed to the British pound’s 6.03% gain over the U.S. dollar; the best performing currency among the G10 economies.
Despite WTI prices stabilizing near $60, the Norwegian central bank (Norges Bank) cut its key rate to a record low of 1%. The main worry for Norway remained the aftershocks of lower oil prices on the economy. Additionally, with the exception of CPI, Norwegian data continued to disappoint, especially in industrial production statistics. The Norwegian krone still managed a small 2.65% gain against the U.S. dollar during the second quarter of 2015.
The second quarter 2015 return for Federated Prudent DollarBear Fund was 1.95% (Class A Shares at NAV). The return for the inverse of the U.S. Dollar (USD) Index was 2.92% for the same period. The fund’s absolute return was largely the effect of U.S. dollar weakness against most of the fund’s currency holdings.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab. Performance does not reflect the maximum 4.5% sales charge for Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
The fund’s performance in the second quarter underperformed its respective benchmark, the USD Index. The outperformance was largely due to a significant underweight in the euro, relative to the fund’s index. The fund did benefit from an underweight allocation to the Japanese yen relative to the USD Index. Lastly, the fund’s complete elimination of exposure to the New Zealand dollar contributed to performance as well.
The uncertainty surrounding Greece will undoubtedly linger in the weeks and months to come. However, regardless of outcome, we think that the closure will have few far-reaching effects. This does not imply however that the fund is apathetic to the potential fallout. On the contrary, the fund has been purposely positioned to absorb the volatility stemming out of the European Union (EU). The fund is properly positioned to navigate its way out of the volatility rather than stand at its mercy. The fund will likely remain overweight the U.S. dollar; a haven vehicle that tends to perform well in times of market stress.
Greece, and the potential for an EU exit, has captivated investor focus for many months now. However, Greece accounts for a very small percentage of total European output. Additionally, nearly 80% of Greek debt is held by the official sector, namely the International Monetary Fund and the ECB. This important distinction should keep contagion effects fairly limited, even in the worst-case scenarios. In the months ahead, investor focus could very well migrate east and begin to centralize more around China than Greece. The real concern could prove to be the slowdown in China and possible excesses in its equity markets. Fund management is exceedingly aware of these potential imbalances and will proactively address the associated implications as they evolve.
Euro-area inflation is likely to stay very low due to weak demand, while the U.S. looks primed for a consumer revival through the ongoing rebound in employment. Mainly, this means that the ECB will need to keep real rates lower than the Fed. Regardless of the outcome to Greece, the inescapable fact is that the ECB is still in the early stages of QE, while the U.S. Fed is entertaining rate hikes. Fund management will most likely remain underweight the euro, versus the U.S. Dollar Index, for this very reason alone.