Invesco Euro Short-Term Bond Strategy Insights

A mixed start to the year with initial optimism over vaccine approval and economic stimulus soon fading. Sentiment turned amid concerns over the emergence of more infectious variants of the virus, delays in the rollout of vaccines in Europe and the impact of limitations on economic activity.
The success of the vaccination programmes in the US and UK was positive for sentiment during the quarter. The speed of these programmes has raised expectations that the US and UK economies will be able to substantially reopen in the summer. A point which was underlined by the UK government’s roadmap out of the pandemic. However, in the Eurozone, the slower rollout of vaccines has meant that many countries have extended lockdown measures.
A big focus for bond markets was President Biden’s US$ 1.9 trillion fiscal stimulus package, which will be in addition to the US$900bn of stimulus agreed last year. The unprecedented amount of liquidity being provided to the US economy has raised inflation expectations. Bonds with longer maturity dates (which are typically more sensitive to inflation) have seen the biggest rise in yields.
The US Federal Reserve has sought to reassure financial markets about this rise by reiterating its commitment to keep interest rates low. Policymakers believe it will be some time before the US economy generates growth substantial enough for it to consider tightening policy.
The expectations for European growth and inflation are less optimistic, as a second wave of COVID-19 infections and the surgency of more infectious strands led to more restrictive lockdowns in several countries. Concerns over the slow pace of the vaccine roll-out and a perception from the market that the European Central Bank might not be as accommodative as was previously being priced in weighed on sentiment. There was also a return of political risk in Italy, with Prime Minister Giuseppe Conte resigning and replaced with former ECB President, Mario Draghi which in turn helped reassure markets.
Source: Invesco, 31 March 2021
Strategy and positioning
- We continue to maintain a preference for investment grade corporate bonds versus government and securitised bonds. We acknowledge the material tightening over the past year, but we still believe they offer an attractive investment profile.
- We expect technicals to remain supportive of corporate spreads in particular for European credit markets. The ECB is currently buying up to €10 billion of corporate bonds per month, equating to just over 1% of the eligible index. Meanwhile, new issue supply should slow down on a year on year basis which will provide ongoing support for the market.
- Within the corporate bond allocation, we remain cautious on sectors with significant pandemic exposure (travel and leisure industries in particular) given lingering demand concerns. However, we are well positioned to capitalise on any dislocations where our credit research team are positive on specific names and we see value in recovery plays such as some specific cashflow positive airports.
- Within peripheral government bonds, we believe the main driver of the market will continue to be the ECB given the quantum of asset purchases completed and the flexibility afforded under the current PEPP programme. As such we have a small overweight position in Italy and Spain and remain broadly neutral in France and Germany as we see some room for spread compression in the current hunt for yield environment.
- Currently the fund is around 27% overweight versus the benchmark in Corporate bonds (on a market value % basis), whilst spread duration remains around 2.4 years. The fund continues to deliver its attractive yield profile whilst maintaining a very high average credit quality of A-.
- In terms of interest rate duration, the fund is leaning slightly underweight versus the benchmark at 1.9 years. Despite core interest rates rising in Q1 (led by the US), we believe it is too soon for the reflation trade in Europe with rates well anchored by ECB policy and structural inflation remains weak. Indeed, whilst a rebound in global growth is our base case for 2021 through the easing of lockdown restrictions in the second half of the year, a return to pre-pandemic GDP levels is not anticipated until at least 2022 across North America and Europe. Therefore, we remain convicted that financial repression/secular stagnation will continue to keep core European interest rates range bound for the foreseeable future. Therefore, although we see little value in duration at current levels, we continue to see it as the most effective hedge to the credit beta of the portfolio should sentiment deteriorate.
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Investment risks
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The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Important information
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All data is as at 31 March 2021 unless otherwise stated.
This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals, they are subject to change without notice and are not to be construed as investment advice.