Federated Global Total Return Bond Fund (A) FTIIX

Share Classes Product Type Asset Class Category
Mutual Fund Intl/Global Global
As of 06-30-2018

Market Overview

Much can be written about global financial developments in the second quarter of 2018, but none would resonate more than just three topics. Specifically, the resurgence of the U.S. dollar, an Italian political crisis and global trade tensions could arguably qualify as the main drivers that shaped financial markets during the quarter.  Early in the period, the U.S. dollar (USD) began to stage its comeback as U.S. 10-Treasury yields attempted to tackle 3%.  Overall, the breach of 3% was more of a psychological formality than some explicit circuit breaker, but it provided fodder for the U.S. dollar.  As both U.S. yields and the dollar began to climb, the emerging markets began to buckle; particularly locally issued debt.

The prospects of an anti-European Union (EU) government in Italy sent shock waves throughout the global bond, equity and currency markets. Italian bonds were at the epicenter of this crisis and endured unparalleled volatility.  Practically no asset class was spared from the aftershocks of the Italian political uncertainties, and the effects resonated throughout the developed and emerging economies. 

As the reporting period drew to a close, the U.S. adopted an even harder line on trade sanctions against a host of countries, but commerce disputes with China remained the focal point. Specifically, the United States Trade Representative council announced tariffs on $50 billion worth of Chinese products.  China countered with proportionate retaliation measures focused on agricultural and energy products.  Subsequently, President Trump then requested an additional penalty on $200 billion of Chinese products if China would proceed with its retaliation.  To say the least, the market’s reaction to this news was not favorable to riskier asset classes.  Subsequently, global equities began to waver, and that exodus found its way into the safety of government bonds.  10-year U.S. Treasury yields dropped well below 3% and German bunds submerged below 0.40%.  This mounting cynicism over world trade clouded what was still a fairly robust global growth backdrop and whittled away at investor confidence. 

From a global bond total return perspective, the uncertainty engendered by trade wars and the Italian elections was not enough to offset the surge in the USD. Consequently, the flagship Bloomberg Barclays Global Bond Aggregate Index was down 2.79%; owing practically the entire loss to currency weakness.

Driven by both haven demand and widening rate differentials, USD strength permeated throughout the second quarter. Divergence in interest rates propelled the USD higher against a host of global economies; the Italian crisis catalyzed that appreciation even further.  Hardest hit were the emerging currencies that not only had to contend with rising U.S. borrowing costs, but with a variety of domestic challenges as well.  For instance, with both the micro and macro environment conspiring against it, the Brazilian real lost over 14.70% in just the past three months.  Developed currencies fared better than their emerging peers, but were not immune to USD strength.  Guilty by its association to Italy, the euro was hard hit and lost 5.19% during the reporting period.  In a wider context, the U.S. Trade Weighted Broad Dollar Index (USTWBROA) gained 4.40% in the second quarter of 2018. 

Japan:

Japan has effectively become the quiet, golden child among the G10 financial community. Japanese bond volatility has been playing nice ever since the Bank of Japan (BoJ) implemented its “curve control” policy back in 2016.  While Italian bonds were suffering titanic volatility shocks, Japanese government bonds remained amazingly subdued.  In fact, 10-year Japanese yields remained in a six basis point range during the course of the reporting period.  As tensions escalated in Europe, an exodus of capital found refuge in the Japanese yen which helped to facilitate the yen’s appreciation across many global economies.  The yen did succumb to the rising USD, but it still managed to outperform most other global currencies.  During the reporting period, the yen was down 4.04%, while benchmark bond returns were up 0.24%.

While many of its developed equals are in the process of winding down legacy quantitative easing mandates, Japan remained committed to its extraordinary monetary agenda. The BoJ kept its short-term rate at -0.1% and its target for the 10-year Japanese government bond yield at around 0%.  The central bank also retained its guideline on Japanese government bond purchases and will continue to buy them "more or less at the current pace" (80 trillion yen annually).  In all, it does not appear that the BoJ is in any hurry to follow in the footsteps of either the Federal Reserve, the European Central Bank or the Bank of England.

Commodity Linked Countries:

Despite the general demand for raw commodities, currency returns of the commodity-bloc economies (Canada, Australia, New Zealand) did not escape the path of the rising USD. However, their respective local bond markets did manage to outperform most of their developed counterparts.  Early on the in period, the central bank of Australia (RBA) made it clear that the next move in rates would be up.  Less than two months later, the RBA would go back on its promise.  In June, the RBA omitted a crucial piece of language in its statement that had favored a future rate hike.  This omission left many investors questioning whether the central bank had become more dovish on interest rates.  Benchmark Australian bonds returned 0.76%, while the currency lost 3.57%.

In similar fashion to Australia, New Zealand’s central bank (RBNZ) turned seemingly more cautious as well. In second quarter, the central bank held interest rates steady, but backtracked on the direction of a future move in interest rates.  Specifically, the RBNZ expressed that the next direction in key rates would be equally balanced.  This announcement did not treat the New Zealand dollar (NZD) kindly, which suffered a loss of 6.48% during the course of the reporting period.

The Canadian economic outlook is a story with two tales. On one hand, the Canadian economy is enjoying low unemployment, stable retail demand, strong GDP and above-average inflation.  However, the second hand is afflicted with trade frictions and NAFTA uncertainties.  Rightly so, trade tensions are putting into question the Band of Canada’s (BoC) objective to raise interest rates further.  The tensions growing between the U.S. and Canada have put a strain on the Canadian dollar which lost 1.77% in second quarter.  However, benchmark bonds benefitted from this subdued rate outlook and were up 0.32% during the reporting period.

U.K.:

After a string of surprisingly upbeat economic data, the tone abruptly soured in the U.K. during the second quarter. U.K. inflation slowed to the weakest level in a year, easing pressure on consumers after months of price increases.  U.K. GDP rose a meager 0.1%, the country’s worst performance since 2012.  As if weakening economic data was not enough, Brexit prospects took a turn for the worse in June.  Specifically, the U.K. government succeeded in overturning a House of Lords amendment that would have given Parliament a more explicit role in the event of a hard EU withdrawal.  This outcome dulled the prospects for a friendlier withdrawal scenario.  In short, the ruling further facilitated the barriers for “hard Brexit” proponents.

As a consequence of the tepid economic data, the Bank of England (BoE) was somewhat more dovish than earlier in the year. Its overall communique still conveyed another rate hike but at a reduced pace, and its forecast revisions were distinctly dovish.  This implied a shallower path for rate normalization than had previously been envisioned.  Shortly after the BoE announcement, investors began to feverishly pare back rate expectations; the British pound was the early shock absorber to this adjustment.  During the course of the reporting period, the British pound lost 5.77%, while benchmark U.K. bonds were practically flat with a 0.12% gain.

Europe:

“It was a quiet period in Europe.” Those are words not uttered during the second quarter.  Leading up to the U.S. Memorial Day holiday, endorsement of a new populist-centric coalition was believed to be nothing more than a simple formality.  Within 48 hours, matters took a striking turn for the worse.  Italy’s president refused to sanction the coalition’s candidate for finance minister, because of his anti-EU principles.  This action unleashed a tidal wave of corollaries; the worst being that Italy would abandon its membership in the EU.  As a result, 2-year benchmark Italian bonds skyrocketed nearly 2% in a single market session.  Remarkably, within 48 hours Italian borrowing costs began to normalize after a new coalition was formed and endorsed by the Italian president.

Prior to the Italian crisis, the future monetary path of the ECB had been fairly clear. Unfortunately, the political tension in Italy significantly muddled the central bank’s objectives.

The economic moderation in Europe, which began to germinate earlier in the year, became very noticeable in the second quarter. The downturn began with a stall to PMIs and migrated over to inflation and consumer confidence.  The German business climate index (IFO) added to its series of declines.  Specifically, IFO’s decline was driven by a drop in expectations, which declined by 1.4 points to a reading of 98.7.  Meanwhile, euro-area HICP (harmonized inflation) slowed to 1.2%Y or 0.1% below what many forecasters were predicting. 

By mid-June, the presiding event in Europe was the ECB’s monetary meeting. The ECB Governing Council once again managed to pull off a “dovish taper”.  It did so by stating that it will end quantitative easing at the end of the year, but changed its language on interest rates hikes to: “at least through the summer of 2019, and in any case as long as necessary.”  This replaced the previous statement that rates would not be changed “for an extended period,” which investors had interpreted as mid-2019.  This cleverly conceived statement incited a 10 basis point drop in German 10-year yields and invoked a sharp drop in the euro. 

As a region, benchmark EU bonds were generally flat on the month, but the composition was very dispersed; a result of heavy Italian losses that were offset by gains in the core countries. For instance, German bunds gained 1.29% while benchmark Italian bonds lost 5.26%.  Suffering from both plateauing growth and political risks, the euro endured a 5.19% loss during the course of the reporting period.

Fund Performance

During the reporting period, Federated Global Total Return Bond Fund had a total return (Institutional Shares at NAV) of -3.18% in comparison to its benchmark, the Bloomberg Barclays Global Aggregate Index (LEGATRUU), which returned -2.79%. The fund’s total return reflected actual cash flows, transaction costs and other expenses that were not reflected in the total return of the index. 

Performance data 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.

Click the Performance tab for standard fund performance.

Click on Portfolio Characteristics for information on quality ratings.

Overall, the fund’s absolute total return was largely attributable to foreign currency depreciation against the USD. An overweight allocation to local Brazilian bonds detracted from performance; weakness in the Brazilian currency was the main factor.  A currency reallocation out of New Zealand and into Norway improved performance relative to the fund’s index (LEGATRUU).  Yield curve exposure had no impact on return, while duration management was an overall contributor to performance once again relative to the LEGATRUU.

How We Are Positioned

Despite the low probability of the U.S. and China engaging in a full-out trade war, the risks are still material. In financial markets such events are coined as “fat tails.”  Tensions are poised to remain high in the weeks and months ahead, clouding both investor appetite and global risk premiums.  Trade conflicts naturally generate uncertainty, and uncertainty spawns volatility.  Consequently, we continue to hold overweight allocations to the Japanese yen.  Not only is the Japanese yen regarded to be undervalued, but it is also one of the preeminent haven vehicles.  It is no surprise that the yen is the only G20 currency that is actually up against the USD this year.  It is a good and efficient shock absorber against uncertainty.

We see little threat of EU withdrawal by Italy, but still find it to be an ongoing source of volatility for the region. Consequently, fund management finds little risk-adjusted value in Italian bonds currently; therefore we remain underweight.  Similarly, but for different factors, we find few incentives to own German bunds below 0.40% and will likely remain underweight German duration.  German data has stalled for the time being, but by no means has it soured.  Additionally, the ECB has not dismissed rate hikes, but simply postponed them by a few months.  Barring an unforeseen exogenous shock, fund management believes that German bunds currently exhibit asymmetrical downside risks along with inadequate term premia.

In the U.K., we expect the rising uncertainty over Brexit to continue as markets navigate their way to the grand finale decision, due in March 2019. In the interim, the BoE will need to delicately juggle monetary policy to simultaneously accommodate high inflation and Brexit risks.  More likely than not, the BoE will choose to err on the side of caution when addressing rate hikes.  Accordingly, benchmark U.K. bonds should begin to outperform many of their developed world equivalents as the BoE embarks on a curtailed hiking path.

USD performance has been bifurcated so far this year. USD weakness resonated in the first quarter of 2018 and then abruptly turned higher in the second quarter.  At closer review, there actually exists a sound rationale behind the USD’s bipolar behavior this year.  Currently, there is a massive push and pull between positive cyclical factors and negative secular forces that are driving the dollar.  The USD has been faced with structural challenges that triggered its decline in 2016.  More recently, however, cyclical winds (mainly widening rate and growth differentials) have begun to swing in the USD’s favor.  This was a key factor why fund management substantially curtailed a legacy USD underweight at the start of the calendar year.


Key Investment Team