Summary

• Emerging markets (EM) became the flash-point during the month, as the combined effects of the stronger US dollar, higher US Treasury yields, and higher oil prices finally combined to break the positive EM story.
• JP Morgan EMBI spreads widened by 30 bps to 366 bps over the month, the highest level since late 2016, being a reflection of the risk-off mood that gripped markets.
• Italian politics caused alarm, with an inability to form a governing coalition raising worries about a move towards populist policy, including the possibility of an exit from the EU.
• On the back of these developments, the US dollar remains the safe-haven currency, with the DXY Index (US dollar) up another 2.3% in the month.
• Global equity markets tracked mostly sideways, with the MSCI All Countries index down 0.2% for the month, and in fixed income, the FTSE WGBI Index was down 1.2%.
• On the back of the most recent developments we cut equity exposure to neutral and opted to make use of higher yields to increase duration.

Market update

The cumulative effect of the consistent rise in US Treasury bond yields year-to-date, the spike upwards in the strength of the US dollar and the more than 10% rise in oil prices during March and April combined to finally crack market sentiment.  Emerging markets (EM) bore the brunt of the risk-off move, with the JP Morgan EMBI spread rising to its highest levels since late 2016.  Emerging market currencies did not escape the move, with Turkey in particular taking a beating, depreciating over 11% against the USD in the month of May alone, taking it to a 19% loss year-to-date.  The spillover into the broader EM space was felt across all asset classes, although the market moves were not as vicious as in May 2013 during what was called the “taper tantrum.”

In the Eurozone, Italy took centre-stage, as internal political machinations ground on.  The inability of any single political party to form a governing coalition meant early elections were on the cards for Italy, and a shift to more populist economic policies is now widely expected.  This included calls for currency separation from the euro, and even to contemplating a complete exit from the Eurozone a la Brexit.  Naturally this added even further to the underlying weak euro trend, with the unit losing almost 6% in value since mid-April.

To add fuel to the fire, the US defied all expectation and implemented tariff increases on imported metals from Europe, Canada and Mexico, with the risk that it may set off a spiraling tit-for-tat round of tariffs on US goods being exported into those areas.  This “America First” strategy is almost certainly likely to alienate the US from some of its closest political and economic allies, and markets will not take kindly to such uncertainty.

Strategy

With most economic and political developments during the month being on the negative side, it was only natural that risk aversion started to rise, with the usual safe havens being the preferred shelter.  We opted during the month to gradually lower equity exposures before ending the month fully neutral against benchmarks.

With bond yields having risen in the early part of the month, we also increased our exposure to the safe haven US treasuries at those higher yields, as well as increase our fund durations.  We have, in line with our overall macro view of rising bond yields, maintained a consistent underweight duration but deemed it appropriate to move closer to neutral on the fixed income side.

No major changes were made to currency positioning during the month and in the short term we still have a positive bias towards the US dollar as well as the Japanese yen, as a safe haven currency. Political uncertainty around Brexit developments means the UK sterling will remain under pressure for the time being.