Tools & Resources▼
|Share Classes||Product Type||Asset Class||Category|
|A IS||Mutual Fund||Alternative and Objective-Based||World Bond|
Unlike some prior reporting periods, no one theme dominated financial markets in the first quarter of 2016. Instead, a host of forces from markets past conspired in tandem to shape the macro narrative. Oil volatility, Chinese economic uncertainty, European Union (EU) deflationary threats and U.S. monetary expectations all forged a hand in defining global risk premiums. However, if one had to describe just one theme that best summarized global markets in the first quarter, it could probably be achieved with just three words: “Negative interest rates.”
Early in the reporting period, the world’s third largest economy, Japan, unhinged global markets when it introduced negative deposit rates. By doing so, Japan effectively placed itself among the growing number of countries where investors now pay governments to buy their bonds. Adding to the volatility, yet another drop in the Chinese yuan led to widespread conjecture that the country’s central bank was embarking on an unofficial currency war with its major trading partners. The reality, however, was more geared at rebalancing the yuan exchange rate relative to the ongoing slowdown in gross domestic product (GDP). The downturn in the yuan wreaked havoc on asset markets and unleashed a wave of deleveraging in the equity sector.
Ongoing concern over supply imbalances in oil inventories added to the turmoil, and sent West Texas Intermediate (WTI) crude valuations reeling lower early in the quarter. The unprecedented volatility in oil prices provided yet another incentive for investors to continue to reduce their equity holdings. At the crest of the deleveraging, most global equity markets were down in excess of 11%. Global government bond markets were on the receiving end of this equity sell-off and benefitted from the general flight to safety.
In the first month of the quarter, the U.S. dollar’s longstanding bullish run started to exhibit signs of fatigue. U.S. dollar gains were becoming much more truncated, perhaps pointing towards the aging cycle of U.S. dollar strength. This subtle observation foreshadowed the U.S. dollar’s fate for the duration of the reporting period. Spurred on by dovish rhetoric from the U.S. Federal Reserve (Fed), the U.S. dollar began to endure losses against a broad array of countries. As the quarter wound to a close, the U.S. dollar had forfeited 6.8% to the Japanese yen and lost 4.77% to the euro.
No sooner after publicly criticizing the European Central Bank (ECB) for implementing negative interest rates, the Bank of Japan (BOJ) had a change of heart and decided to mimic its European counterpart. In January, the BOJ, joined its European counterpart and implemented negative deposit rates. Initially, the announcement of “qualitative easing” collapsed both Japanese yields and the yen. Prior to the declaration, 10-year Japanese government bonds yielded 0.22%, and by the end of the reporting period had a negative yield of nearly -0.10%. Counterintuitively, the Japanese yen then began to strengthen throughout the period and was the second best performing currency in first quarter among the G10 nations.
Like so many other central banks, overall rhetoric from the BOJ on economic development was almost continuously downbeat. The economic assessment, especially on exports and housing, was revised down by the central bank. On the policy front, the BOJ reiterated that, if needed, it would take additional easing measures, including the quantity of money, type of eligible assets and even deeper rate cuts. Notably, the BOJ Governor stressed that further rate cuts remained a viable solution. Consequently, Japanese government bonds (JGB’s) were some of the best-performing securities within the developed community.
Commodity Linked Countries:
It was a roller coaster ride for the commodity-related economies, and much of it was a consequence of events in China and oil valuations. At first, most commodity-linked economies fell prey to falling oil prices and concerns over China. Generally speaking, commodity producers led losses in Europe and currencies, including the Canadian and New Zealand dollars, suffered greatly. However, as the chorus of easy monetary policies grew vociferous, the commodity sector staged an abrupt turnaround. In sharp contrast to past cycles, the closer an economy was tied to commodities this time, the sharper the ascent was for its currency. For example, heavily reliant on commodity exports, the Australian dollar was one of the top-performing currencies, returning 5.09% against the U.S. dollar. Similarly, as oil prices began to accelerate higher, the Norwegian krone followed suit and posted a 6.95% return; the top-performing currency in the G10’s last reporting period.
In Canada, the pickup in total inflation seemed fragile at first, but as WTI prices began to rise, expectations for additional easing waned. Subsequently, the Bank of Canada did not alter key interest rates. Consequently, a battered Canadian dollar began to reverse abruptly, and by the conclusion of the quarter, was up 6.42% against the U.S. dollar.
Surprisingly, Australian gross domestic product increased 0.6% from the previous three months, compared with the median estimate for a 0.4% gain. The report revealed an economy that added the most jobs on record as industries, including tourism and education, capitalized on a lower currency and weak wage growth. The RBA kept rates unchanged at 2%, betting that existing stimulus and the drop in the oil prices would help offset retreating mining investment.
Coined “Brexit,” concerns over the U.K. leaving the EU governed most economic affairs in the past reporting period. Making matters worse, EU cessation risk suffered a setback after one of the U.K.’s most popular politicians began to endorse the idea of Brexit. Meanwhile, it was also becoming clear that economic activity in the U.K. was beginning to slow as well. In January, the Bank of England (BOE) made this observation official. In a communique, financial authorities said the near-term outlook for U.K. growth and inflation had weakened further, and that was the reason why key lending rates were kept at a record low.
A dovish central bank, in conjunction with growing uncertainty over the EU referendum vote, inflicted turmoil on the British pound (GBP). Having been one of the better-performing currencies last year, the GBP was one of the rare currencies that actually lost ground to the U.S. dollar last quarter. The British pound surrendered 2.55% to the dollar. However, as the Bank of England delayed its projections for a rate hike, U.K. bonds grew more alluring. Benchmark U.K. government bonds outperformed most other developed-country bonds.
Deflation once more raised its ugly head in Europe. The euro area’s annual inflation rate dropped back below zero. This return to negative territory was a symbolic setback for the ECB and provided it with the necessary fodder for bolder easing measures.
Troubled by the precipitous fall in inflation, Mario Draghi (ECB president) delivered a broad range of easing initiatives that surpassed most official expectations. Unquestionably, the most surprising element was the inclusion of non-bank corporate bonds in the quantitative easing program. The ECB also surprised on the asset purchasing side by increasing the pace to €80 billion per month. When questioned, Draghi stated that European monetary policy might be nearing its lower boundary limits. Despite the vast easing initiatives, this single comment triggered a steep rally in the euro; an unwelcome response for any central bank trying to rouse inflation.
Draghi’s reference to boundary limits, in conjunction with incessantly dovish commentary from the U.S. Fed, helped the euro gain 4.77% against the U.S. dollar during the period. Lastly, extraordinary easing initiatives and a general flight to safety allowed core European bonds to outperform their peripheral EU equivalents during the first quarter.
During the reporting period, Federated Prudent DollarBear Fund had a total return of 5.10% (Class A Shares at NAV). The return for the inverse of the U.S. Dollar Index was 4.10% for the same period. The fund’s absolute return was largely the effect of U.S. dollar weakness against the bulk 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.
Removal of an overweight allocation to the U.S. dollar benefitted performance relative to the fund’s index. Additionally, an overweight allocation to the Japanese yen, relative to the fund’s index, improved return. Lastly, gold and equity selection greatly benefitted fund performance relative to the inverse of the U.S. Dollar Index.
The U.S. Federal Reserve has gone global. The first quarter of 2016 was ripe with volatility and idiosyncratic economic themes. However, as the period progressed, it became evident that all the varying economic themes were coalescing into a singular macro narrative: “Global growth.” This was a subtle, yet important, shift in how financial markets were operating. Be it the price of oil, Chinese GDP, or U.S. monetary policy, prior reporting periods typically had a very identifiable driver. At present, the main concern for most investors is global growth. This is an important distinction because global growth is a ‘macro’ topic by composition and needs to be attended to that way. Applying bottom-up techniques in a macro-driven world could prove problematic and lead to flawed conclusions. Looking forward, top-down economic analysis will very likely prove critical in correctly assessing a multitude of risk premiums across asset classes.
The Fed has gone out of its way to elevate the importance of global risk factors as a consideration to U.S. monetary policy. It’s probably fair to say that had the global outlook been more stable, the Fed would have hiked rates again by now. The Fed’s employment mandate has been more than met, but its inflation objectives are being severely hindered by external factors. Effectively, U.S. interest rates are now as much a global consequence as they are a United States corollary. It is ironic that the trigger for higher rates in the U.S. might very well stem from a pick-up in Chinese domestic growth, or a resumption of inflation in Europe. These are key elements that fund management will monitor very closely, because the potential effects will undoubtedly have repercussions on all markets.
“Stop being so negative!” Last quarter was yet another period where the world’s largest central banks entrenched deeper into negative monetary mandates. So far, these policies have yet to bear any real economic fruit for either Japan or Europe. For the time being, the main transmission channels behind negative rates appear to be backfiring on both the BOJ and the ECB. Since implementing this policy, the Nikkei has made new lows, while the yen has strengthened dramatically. To a lesser degree, a similar fate has plagued equity markets in Europe, and also has led to the strengthening of the euro. Consumer sentiment has deteriorated in both regions and both financial sectors have been thrashed. However, this is not to suggest that these policies are unsound, but more to imply that their outcome remains unclear and warrants very close scrutiny. Fund management is keenly aware of these risks and will continue to actively monitor their progress.
Recently, the euro has been a formidable currency, but a stronger euro is also in direct conflict with the intentions of the ECB. Consequently, relative to the fund’s index, we remain underweight the euro. To be fair, the U.S. dollar remains a standout destination for those investors seeking positive yield and trivial credit risk. However, a host of other currency valuations are growing extremely attractive. Relative to the fund’s index, fund management will likely maintain overweight allocations to securities denominated in the currencies of Japan, Norway and Sweden. The European Central Bank appears more committed than ever to ongoing quantitative easing. Accordingly, we remain constructive on European peripheral bonds.
Finally, our gold and gold stock weighting, relative to the U.S. Dollar Index, was a significant contributor to the overall performance during the reporting period. Given the elevated risks to credit and the global economy, it has become clear that the Fed, and other central banks, are more than willing to err on the side of accommodation. This, at the margin, is gold positive. Accordingly, Fund management is likely to continue holding gold securities.