Miles Geldard, co-manager of the Jupiter Strategic Reserve Fund comments on the institutional fund’s outlook…
The strong rally in risk assets triggered by the ECB’s massive action to avert a liquidity (and solvency) crisis has run its course. However, when it comes to making progress towards a unified politico-economic solution to the eurozone’s fiscal fracture, Germany’s behaviour is instructive. Rather than throw a lifebelt to a drowning man it insists he takes swimming lessons. In contrast, the IMF, that arch advocate of austerity, has warned Europe that excessively punitive measures are counterproductive to economic growth.
Our primary focuses are interconnected: the overvaluation of sovereign bonds and anomalies in certain currency values. We believe that imbalances in the latter lie at the root of the problem facing financial markets. They have also created some extreme valuation distortions. We anticipate weakness in the yen, the South African rand, the euro and the Australian dollar. Our largest positions are negative duration exposures in certain western sovereign bond markets.
The Australian dollar has been unusually strong thanks to huge inflows into its sovereign bonds from overseas investors attracted by the comparatively high yield and triple-A rates safe haven status offered and wary of the dollar and the euro. In August 2011, the Greek debt crisis hit markets hard and intensified concerns. The bonds of safe havens such as Canada and Australia benefitted.
We began to take profits, selling into strength gradually. By the autumn, the Reserve Bank of Australia began to cut interest rates. In November it cut 25bps to 4.50% and then again in December to 4.25%. We reduced our holdings further and closed the remainder of our position in March 2012 after the bonds reached our yield target.
As Switzerland found out, safe haven status can force up a currency to unhelpful levels. In Australia’s case, a reliance on foreign ownership of its sovereign bonds alongside a fully-inflated property bubble and a waning in demand from the biggest buyer of its raw materials makes for a potentially fragile situation. In our view, the level of real interest rates put highly-leveraged households under pressure. We therefore think there is room for further rate cuts and for the Australian dollar to fall against the US dollar. We are positioned accordingly.