Liontrust GF Strategic Bond Fund

The Liontrust GF Strategic Bond Fund returned 1.3%*in US dollar terms in September. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was 1.1%.

Market backdrop

The main event in the bond markets in September was the US Federal Reserve interest rate cut. In the build up to the Federal Open Market Committee (FOMC) meeting there was a lot of debate about whether rates would be cut by 25 basis points (bps) or 50bps. In the end the Fed opted for a 50bps reduction to take the range to 4.75% to 5.0%; the move was marketed as a recalibration of policy. The vote split was 11-1 with Bowman favouring a 25bps cut in the first dissenting vote since 2005.

The FOMC meeting was accompanied by the quarterly update of the Fed’s Summary of Economic Projections (SEP). In my opinion a compromise was reached with a starting 50bps rate cut but then the dot plot forecasting a pace of cuts of 25bps at each of the two remaining meetings this year. The Fed’s shifting focus from the inflation to the full employment part of its mandate is clear to see as it states “…the risks to achieving its employment and inflation goals are roughly in balance.” This led naturally to the rationale for the cut being “…in light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point.” With economic activity still characterised as being “solid,” Chair Powell’s emphasis is that this rate cut is about “recalibration” of monetary policy.

The dot plot of FOMC members’ current projections for rates shows the disparity of views on the Committee. The median case for two more 25bps cuts, to take Fed funds rates to finish 2024 in the 4.25% to 4.50% range, only has a slim majority on the FOMC. There are 100bps of further cuts projected for 2025 with an additional 50bps completing the easing journey in 2026; the further one looks into the future the greater the disparity there is between FOMC members’ views. One development that will become more important in 2025 is the debate about where longer-term neutral rates are; the latest SEP added 0.1% to terminal rates, taking them from 2.8% to 2.9%.

Powell did a great job at the press conference phrasing the 50bps as a recalibration, so the Fed is neither overly concerned about current conditions nor embarking on a series of rapid rate cuts. One quote that many have latched on to is “…I do not think that anyone should look at this and say, ‘Oh, this is the new pace,’” with Powell then saying “…the economy can develop in a way that would cause us to go faster or slower.” I continue to expect the US labour market to exhibit further softening, driven by both the increased supply of labour and lessening demand, particularly amongst SMEs who are feeling the crunch more in this cycle. With the US consumer remaining robust, I do not anticipate a collapse in employment. My view remains that US unemployment will peak somewhere in the 5% - 6% range in this cycle. If I am correct that the labour market will gradually keep easing, then the Fed will undertake further 50bps cuts – whether this is in 2024 or 2025 remains to be seen. Fears over a non-linear labour market (when things start to go wrong, they do so rapidly) are likely to motivate the Fed to approach neutral rates sooner rather than later.

While the Fed was the main event, other central banks are definitely worthy of a mention. The European Central Bank (ECB) cut rates by 25bps to 3.50% as was expected by all surveyed economists and market pricing. The rationale for this cut was “…based on the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to take another step in moderating the degree of monetary policy restriction.” The guidance remains very non-committal: the ECB “…will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.”

The staff forecasts saw their quarterly update; the headline inflation projections are unchanged while core inflation projections for 2024 and 2025 were revised up by 0.1% “…as services inflation has been higher than expected.” The ECB argues that domestic inflation is high due to continued rises in wages; however, it goes on to note that “…labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation.” There was a downgrade to growth forecasts mainly due to weaker domestic demand. I’d argue that these updated forecasts give a good balance between hawkish and dovishness; the ECB has marked-to-market sticky services inflation in its forecast for core CPI, however easing wage pressures and weak domestic consumption suggest downside risk in the longer term.

Finally, the Bank of England’s Monetary Policy Committee (MPC) held interest rates steady at 5.0% as was widely anticipated. The vote split was 8-1 with Ramsden going with the majority, leaving Dhingra as the sole dove voting for a cut. There was one important sentence added to the guidance paragraph of the MPC’s statement: “…In the absence of material developments, a gradual approach to removing policy restraint remains appropriate.” This strongly hints that the MPC is not in a rush to do back-to-back interest rate cuts, nor do they want to deviate from 25bps increments. The next MPC meeting is in November when it will be accompanied by an updated quarterly monetary policy report. An interest rate cut at the MPC’s November meeting would be very likely anyway even if the UK did not have an Autumn Budget on 30th October which will see taxes being raised.

Fund positioning and activity

Rates

The Fund’s duration was maintained at 6.5 years during September. Underneath the headline figure there was a cross-market adjustment: US Treasuries have outperformed their European sovereign cousins and when the yield spread between the 10-year Treasury and 10-year German Bund got as low as 150bps we switched 0.5 years of duration from the US into Bunds. The geographic split of duration is now 1.9 years in the US, -0.5 years in Canada, 1.0 years in New Zealand, 2.3 years in the Eurozone, and 1.9 years in the UK.  

As a reminder, we continue to think that yield curves will steepen further, the Fund’s net duration exposure in the 15+ year maturity bucket is zero; we prefer short-dated and medium-dated bonds.  

Allocation and selection

Credit spreads remain expensive by historic standards. The Fund is underweight with 43% in investment grade and 14% in high yield (20% in bonds minus a 6% overlay), compared to neutral levels of 50% and 20% respectively. Credit fundamentals remain robust and we are just awaiting a better valuation opportunity to increase exposure.

Dispersion between individual corporate bond valuations still allows us to add value at the stock level. Purchases during September included debt issued by the Irish food and ingredients company Kerry, logistics focused property company Segro, and a subordinated bond from the Italian gas network company Snam. On the sales side of the ledger, the Fund’s position in VW was sold as swathes of the automotive industry are struggling with competitive pressures.