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The first quarter of 2015 was riddled with a variety of event risks and heightened volatility, but surprisingly developed market performance remained fairly robust. Fueled by the European Central Bank’s (ECB’s) quantitative easing (QE) initiatives, nowhere were these returns more pronounced than in Europe. On average, local European equity markets returned 18%, and their bond market counterparts 4%. However, U.S. dollar appreciation was yet another formidable force in the quarter and detracted from practically all local returns - both emerging and developed markets alike.
“Good news/bad news,” earmarked the state of the Japanese economy in the first quarter of 2015. Real GDP resumed growing, putting an end to back-to-back quarterly declines, and technically exited Japan out of recession. However, the rate of this pick-up was widely below the 4% increase that most economists expected. Japan may have escaped recession, but did so at a disappointing pace. Despite ongoing QE by the Bank of Japan, the yen was the second best performing currency in the G10 community and only relinquished -0.30% to the U.S. dollar.
For some time now, the economies of Australia, New Zealand and Canada had all been struggling with the realities of lower commodity demand. The abrupt rise in currency volatility last quarter took matters from bad to worse for all three currencies. In New Zealand, headline inflation experienced its first decline since 2012. Having been one of the first major central banks to hike rates after the financial crisis of 2008, the Reserve Bank of New Zealand (RBNZ) signaled an end to its tightening bias last period. In Australia, the central bank unexpectedly cut its benchmark interest rate to a new record low and stated that the local currency remains overvalued. Not to be outdone, The Bank of Canada cut key interest rates as well by 0.25%.
A weak commodity complex in conjunction with dovish central bank mandates did not bode well for the currencies of this trio. The currencies of Australia, New Zealand and Canada relinquished ¿6.95%, -4.19%, and -8.40%, respectively to the U.S. dollar
As expected, the ECB delivered an expansion of its asset purchase program to include sovereign debt. Total purchases would amount to €60 billion per month. Notably, the program was intended to end in September 2016, but could also extend beyond that date if necessary. This was possibly the most important distinction, the announcement was absent of a hard coded end date. In theory, Europe’s QE could extend well beyond the “recommended” date of September 2016.
A secondary European narrative last quarter was almost entirely a replay of events that made headlines in 2011. With a newly elected Prime Minister at the helm, prospects for yet another Greek default began to resurface. The potential consequences of a “Grexit” did reverberate through global markets, but the volatility was more muted and shorter lived than the 2011 episode.
Despite the volatility infused by these dueling forces, Greek sovereign default and QE, most European peripheral bonds still generated handsome local returns. However, when adjusted back to U.S. dollars, European bond returns were overwhelmed by euro weakness, which surrendered 11.25% to the U.S. dollar during the reporting period.
U.K. and the Nordic Economies:
Like so many other economies, inflation in the U.K. also took a downward turn in the first quarter of 2015. The majority of the downward pricing pressure was almost entirely a subset of falling energy prices. Consequently, members of the Bank of England voted unanimously to keep rates on hold after being divided in prior official announcements. The British pound lost 4.7% to the U.S. dollar. Despite this loss, the pound was still one of the better performing developed currencies on a relative basis.
With West Texas Intermediate Crude prices off in excess of 40% from their 2014 highs, it was no surprise that consumer confidence for the world’s seventh-largest oil producer would begin to decline as well. Norway posted a string of consumer sentiment drops in the first quarter. Interestingly, neither Norwegian employment nor inflation manifested the effects of lower oil prices. Norwegian unemployment continued to anchor around a healthy 3% and Consumer Price Index (CPI) was comfortably stationed at 2.0%. Sweden continued to combat deflationary forces sourced from weak European export demand. Late in the quarter, the Riksbank (Swedish Central Bank) surprised markets by cutting its main policy rates to -25% and further upsized its own QE program. The move clearly underlined the dovish bias at the Swedish central bank.
The first quarter 2015 return for Federated Prudent DollarBear Fund was -4.14% (Class A Shares at NAV). The return for the inverse of the U.S. Dollar Index was -8.96% for the same period. The fund’s absolute return was largely the effect of U.S. dollar strength 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 first quarter outperformed its respective benchmark, the U.S. Dollar Index. The outperformance was largely due to a significant underweight in the euro, relative to the Fund’s index. The fund also benefited from an underweight allocation to the Japanese yen relative to the U.S. Dollar Index. Lastly, the fund also had an overweight allocation, relative to the U.S. Dollar Index, in the Swiss franc, which also benefited performance.
European QE and a strengthening U.S. dollar proved to be bookend themes for the opening quarter of 2015. These two economic forces will very likely persist in the coming months and continue to sculpt global risk premiums. Likewise, monitoring the state of the Energy sector will prove pivotal in deciphering the overall trajectory of inflation. The price of oil has rarely been as important to global markets as it is today. All the formerly mentioned factors will play directly into yet another pillar economic consideration: U.S. monetary policy.
The outlook for interest rates in the United States will not only drive the U.S. dollar, but have consequences on the direction of global bonds as a whole. A focal discussion over the next months will once more revolve around the timing of a U.S. Federal Reserve rate hike. Recently, the nature of this decision has become much more global in composition. With such a striking divergence from its G10 peers, U.S. monetary decisions will likely begin to incorporate more international inputs.
European QE has exhibited ample promise thus far; all three of its transmission mechanisms appear to be firing on all cylinders. The price action in the EU bond markets has been very rewarding; this is despite all the uncertainty in Greece. European equity markets are making record highs, and the Manufacturing sector is being energized by a weaker euro. There is also strong evidence of improving trends in both consumer and business confidence. Nevertheless, the risk in Europe remains skewed to the downside, but has diminished materially in the past three months.
Fund management expects inflation in the EU to remain very low, but to start increasing gradually as oil prices bottom. Central to this recovery is one critical element: continuing weakness of the euro. A strong currency defeats one of the major covenants of any QE program. This is a primary reason why we remain structurally negative on the euro. Fund management continues to hold a significant underweight in the euro relative to the U.S. Dollar Index.