MACRO AND MARKET REVIEW
June proved to be another constructive month for fixed income investors, with improvements in the Middle-East providing respite. Government bond markets continued the recovery from their war-induced volatility, while credit moved marginally wider on the month despite improving sentiment around energy markets. Euro-denominated assets again outperformed many USD counterparts, supported by stronger duration performance in lieu of a softening inflation outlook and a retracement in energy prices.
The key development during the month was the signing of a Memorandum of Understanding (MoU) between Iran and the US, opening a 60-day ceasefire agreement to allow for further negotiations towards a longer-term peace agreement. Following the MoU, vessel traffic partially resumed through the Strait of Hormuz and oil markets responded swiftly, as brent crude fell sharply back towards pre-conflict levels. While negotiations remain ongoing and sporadic security incidents continue to highlight the fragility of the situation, markets increasingly viewed the worst-case energy supply scenarios as less likely.
The moderation in energy prices was particularly important from a macroeconomic perspective. Inflation concerns had dominated market discussions throughout the second quarter, but June data provided the first signs that the energy shock may not spread broadly as had been feared. Eurozone headline inflation slowed to 2.8% from 3.2% in May, while core inflation also eased. Across the Atlantic US inflation was similarly well behaved, showing little sign of broader pass through. Ultimately, although price pressures remain above central bank targets, the direction of travel was encouraging and helped support a broader rally across duration markets, particularly in Europe.
Central banks nevertheless maintained a cautious stance. The ECB raised its deposit rate by 25bps to 2.25%, citing continued inflation risks stemming from the energy shock and a desire to keep inflation expectations anchored. The Federal Reserve left rates unchanged, with policymakers signalling concern that inflation remains above target alongside a still-resilient economy. Despite the progress on the war and inflation front, both decisions emphasised that inflation concerns still trump growth concerns in eyes of central banks.
June also marked the first Federal Reserve meeting under new Chair Kevin Warsh. While rates were left unchanged, the Fed adopted a more hawkish tone, removing language that had previously pointed towards eventual rate cuts. Warsh also signaled a reduced emphasis on forward guidance, declining to participate in the Fed's traditional "dot plot" projections and stressing a more data-dependent approach to policy. The move away from explicit forward guidance will likely lead to more volatility in front end US rates in the coming years, a trend that is likely to heavily shape future fixed income performance.
PORTFOLIO ACTIVITY
In June, we maintained the strategic long-duration bias held since the sharp repricing of global interest rates following the energy price shock. At the same time, we took partial profits on some positions, particularly in the Eurozone, using periods of headline-driven volatility to trim exposure, notably around the signing of the Memorandum of Understanding between the United States and Iran.
PERFORMANCE
Relative performance was broadly unchanged on a gross basis in June.
Tactical duration positions, predominantly long-biased, contributed positively to returns, while the quantitative volatility strategies modestly detracted from performance. The sovereign allocation to highly rated issuers was neutral in relative-performance terms over the month, while enhanced beta tilts weighed slightly on results.
Since the start of the year, tactical interest rate positions have been the main drivers of relative performance. The fund's gross return is ahead of the market-cap index on a year-to-date basis.
OUTLOOK
All in all, in the face of more geopolitical developments fixed income delivered another steady month of strong performance. Further easing of energy concerns and softer inflation data would support a more constructive backdrop for government bonds moving forward, while strong corporate fundamentals and sustained investor demand continued to underpin credit markets. Although risks remain and vigilance is still warranted, the asset class has navigated recent volatility well, leaving credit attractive from a carry perspective and the outlook for duration more balanced than at the start of the month.
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