CC JCB Global Bond B Unhedged (CHN1425AU) Report & Performance

A large miss in Australian inflation data for the second quarter reinforces the global disinflationary theme which is bringing Central Banks towards terminal rates after a vicious interest rate hiking cycle. Global supply chains have normalised, abating inflation in most goods and materials, whilst commodity and energy markets have cooled considerably from the shock disruptions around the outbreak of conflicts between Russia and Ukraine. It is likely that many Central Banks have delivered their final rate hikes on a preset path and will now be driven by ‘data dependency’. We believe this is the end of ’forward guidance,’ a key pillar of policy communication since the global financial crisis (GFC), with communication having more strategic ambiguity. After such a dramatic shift in the global cost of capital, a ‘pause and assess’ moment is warranted as inflation cools, settling towards its mid -run trend in a post pandemic world. The recent decrease in inflation numbers is certainly a significant relief compared to the lofty peaks of 9% in US CPI. The last year on year reading was down to just 3%. However, the fight for ’the last mile’ towards the inflation target of 2-3% will not be a simple task, as the easiest part of disinflation (the base effect of data rotation) is now complete, making the journey towards the target more challenging.

As inflation picked up around the world led by US markets, Australian inflation was a material laggard in the global process, with a more than six-month lag to US data. US year on year inflation numbers exceeded 4.00% in April ’21, whilst Australia did not breach this 4.00% level until Jan ’22. As global inflation pressures have abated with the normalisation of supply lines and goods prices, further falls in domestic inflation should be expected following this lower momentum and global trend.

As we look ahead, there are competing forces at play that will impact inflation. On one hand, there is a decline in services inflation, driven in large part by rents and slowing global economies. On the other hand, the cyclical nature of the commodities and energy cycle will have an impact. As a result, is it anticipated that US inflation, acting as the global barometer, will stabilise between 3-4% over the balance of 2023. Specifically, the July data is expected to show a slight increase to 3.2%.

The good news on the inflation front is that these competing data forces should significantly moderate the rates of change. Services inflation should continue to fall, driven by the large category of owners’ equivalent rents, which exhibit a long lag within inflation data due to annual rental resets at CPI inflation levels. This creates a classic self-reinforcing loop, making it challenging to break, where rental agreements are extended as they fall due at spot CPI year on year levels, on a rolling basis. This feeds previously high CPI figures into rental prices, thereby increasing future CPI with higher rental prices in that subcomponent, given the long lag until headline inflation cools (headline is now 3%) and the data enjoys relief with a laggard period. Continued cooling in this important subcategory should help to deliver lower headline inflation and reduce the volatility of the incoming data series, as it settles towards trend after a period of violent amplitude. The addition of the fastest and largest rate -hiking cycle in a generation should temper demand, aided by easing supply conditions and the expected softening of the labour market, responding to the ongoing monetary policy tightening that began in global markets over a year ago.

Following on from the volatile start to the year, the second quarter was a touch more subdued for asset markets as financial contagion from the banking issues of March remains contained for now, however the impact and the direction of global interest rates continued to be hotly debated and closely monitored as we approach the zenith of the tightening cycle. The cumulative effects of Central Bank tightening continue to keep participants on watch as the timing of the global recession remains hard to isolate, particularly given the conflicting evidence that is arising from key data and the divergent directions of different asset classes .

The manufacturing sector is historically a prescient indicator of the state of the economy and probably best reflects the global story, whilst the services component of that sector runs hot on pent-up consumer demand. The manufacturing survey remains steadfast in recessionary territory due to tightening lending standards and the higher cost of capital. This divergence is creating headaches for the monetary authorities as goods inflation continues its trajectory lower, whilst services inflation remains sticky. Central Banks face a delicate balancing act as they strive to steer inflation into an acceptable level in the “vicinity” of the mandated 2% level – creating a challenging conundrum.

Like the concerned parent threatening their recalcitrant children to implement a ban on all electronic devices in the household, we expect to see continued tough talking from Central Bank officials as they steer markets away from pricing in a rate cutting cycle in the near term.

This was evident at the recent Central Baking Forum in Sintra, Portugal where Federal Reserve Chair Powell , European Central Bank President Lagarde, Bank of England Governor Bailey, and Bank of Japan Governor Ueda , all waxed lyrical on monetary policy and their prospective thoughts. With the exception of Ueda, who acknowledged that underlying inflation in Japan remains below 2%, all others emphasised their commitment to combat inflation and are adapting policy to achieve that goal. The Central Bankers also suggested their respective institutions will now be moving interest rates on a meeting-by-meeting timeframe as they become data dependent. This underscores the uncertainty with regards to the global economic outlook and the perils of implementing monetary tightening late in the cycle.

Consider Europe as an example, where stubborn inflation and the Central Bank’s aggressive round of interest rate hikes have inflicted pain on the Eurozone economy, leading to a technical recession with real GDP declining by 0.1%, quarter-over-quarter in the final quarter of 2022 and the first quarter of 2023. Furthermore, the once proud German economy now bears the unfortunate label of the “sick man of Europe,” as recent employment weakness has pushed the unemployment rate to a two year high of 5.7%.

For the month ending May, the CC JCB Active Bond Fund – Class A units (the Fund) returned -1.27% (after fees), outperforming the Bloomberg AusBond Treasury (0+Yr) Index.

Overall the month of May saw global yields drift higher in yield across developed markets as markets took out pricing of rate cuts that had appeared in 2024 money market curves as a lingering outcome of the banking worries of March. Central bankers globally pushed back on this pricing. Outside of central banks and data, the other key catalyst driving headlines in markets was the pending debt ceiling negotiations, with parties finding enough common ground to send the deal to the Senate by the final week of the month.

The US 10y yield finished the month 20 basis points (bp) higher at 3.65%, and the Australian 10year bond was 30 bp higher to 3.59%. Central banks continued to tighten policy with the Reserve Bank of Australia (RBA) surprising the market with a 25bp hike to 3.85%, whilst the Reserve Bank of New Zealand, European Central Bank and Bank Of England all delivered 25bp rate hikes as expected lifting rates to 5.5%, 3.25% and 4.5% respectively. The RBA had been expected to pause at the May meeting, however the 7% yoy CPI print for Q1 and a 3.5% unemployment rate was too compelling for the RBA to sit on their hands, especially on the back of the RBA Review findings, and the desire to maintain credibility and prevent inflation expectations from spiraling higher. The portfolio overall traded a short bias on the month, as JCB believed the market was pricing in too much easing in the face of sticky inflation. Price momentum towards higher yields added to our bearish sentiment, however JCB turned long at 3.75%. JCB believe that entry levels of between 3.75-4% are very attractive medium term levels to be adding to long duration positions ahead of the northern hemisphere summer where bonds seasonally have seen strong performance historically.

For the month ending April, the CC JCB Active Bond Fund – Class A units (the Fund) returned 0.11% (after fees), outperforming the Bloomberg AusBond Treasury (0+Yr) Index. The month of April was somewhat calmer than the extreme volatility that the bond market experienced in March .

Overall, Australian 10yr bonds traded a yield range of 3.15% to 3.56% (a range of 41.5 basis points (bp) vs 84bp in March). This was seen as a consolidation month, affected by the school holidays, Easter and ANZAC Day breaks locally. Banks were in the headlines again this month following the events of March (notably SVB and Credit Suisse collapses), as risk sentiment remained shaky.

Short sellers continued to look for opportunities of weakness in specific bank names that were exhibiting weaker fundamentals and deposit outflows with great success and profiting handsomely from these trades. US data was mixed, with inflation staying sticky and the jobs market staying tight, while aspects of growth are showing signs of slowing down. The Reserve Bank of Australia (RBA) paused for the first time in the current rate hiking cycle at their April Board meeting to “assess the impact” of the increases of rates to date and awaiting the all important quarterly inflation data in the last week of April.

The Reserve Bank of New Zealand (RBNZ) on the other hand surprised the market by hiking 50(bp) at their April Board Meeting in the face of upside risk to medium term inflation expectations . Looking forward, as at the end of April, the RBA had one more rate hike priced in for 2023, while the FOMC was pricing in a cutting cycle. JCB sees the end of the hiking cycle as very close to done now and it will take an acceleration in inflation to see cash rates move significantly higher. Whilst possible, this is likely to be an exogenous shock.

On the other hand, things are starting to break in the economy (e.g. regional banks) and if this does see contagion spreading and confidence in the system to continue to diminish, then rate cuts could be on the agenda some time in early 2024. In what was a heavy issuance month with a new syndicated ACGB 2034, the Active Bond Fund traded with a short duration bias into the large bond issuance event.

The Fund was overweight the 2yr part of the semi-government and Supranational curve which added positive alpha and also benefitted from a steepening 10×30 curve position.

For the month ending March, the CC JCB Active Bond Fund – Class B units (the Fund) returned 3.58% (after fees), outperforming the Bloomberg AusBond Treasury (0+Yr) Index.

March 2023 is one of the months that will go down in history as one of the most volatile of all time. The MOVE Index (the bond market version of the VIX that measures daily volatility) hit levels not seen since the depths of the COVID-19 crisis of March 2020. Over a period of 13 trading days straight, the 2yr USTs traded an unprecedented 20 basis point (bp) daily range. These are not normal times! So what happened..?

The biggest event was the collapse of Silicon Valley Bank (SVB) which sent shockwaves through the financial markets. It was March 7th when US Federal Reserve, Chair Jerome Powell, noted “Nothing about the data suggests to me that we’ve tightened too much” before the Senate Banking Committee. By March 8, SVB was in trouble and raising capital, and two days later SVB was gone. This is an example of the ferocity of the financialisaton of the banking work, with deposits in the order of $42bn withdrawn in a matter of hours via online transactions, in a practice that back in the days of the GFC would have taken weeks to see people lining up once the branch opens on a given morning.

The next bank to fall was Credit Suisse, an institution with 160 years of history, and then rumours also were swirling about Deutsche Bank being in trouble, although this was driven by a CDS trade with a measly notional of just $5million. This is a minor trade in the scheme of things, but we are not living in normal times.

On the data front, inflation and employment continue to be the big ticket items and receiving the most attention from market participants. Tight employment conditions globally continues to be a thorn for central bankers, while inflation data is easing, however still at uncomfortable levels. In the face of the data, the Federal Open Market Commitee , European Central Bank and Reserve Bank of Australia all continued their mission to focus on the inflation fight and hiked rates at their respective meetings, although we are now getting to a point where things are starting to break , which has been their aim all along by providing headwinds to the economy with the increasing cash rates and therefore cost of money.

For the month ending February, the CC JCB Active Bond Fund – Class A units (the Fund) returned -1.43% (after fees), outperforming the Bloomberg AusBond Treasury (0+Yr) Index. The month of February saw bond yields grind higher and curves flatter as key global data points showed signs of reacceleration, and inflation data surprised to the upside, in a move that was not pleasing to the worlds central bankers. February began with bonds rallying and saw 10y UST yields trade as low as 3.35% before the data surprised to the upside, which was a catalyst for hawkish rhetoric from central banks from both sides of the Atlantic, and right down to Australia. The explicit warings that rates may need to stay higher for longer saw the 10y UST traded up to 3.98% which was where we finished the month. Locally, the RBA lifted the cash rate by another 25 basis points with the promise of more to come following the stronger than expected CPI print at the end of January, noting that “further increases in interest rates will be needed over the months ahead.”. As the month passed by however, Australian data began to see the effects of the higher rates begin to hit the consumer, as retail sales, monthly CPI data, wages and unemployment data all surprised to the down side, which brought fears that Australia may in fact be getting towards the end of the hiking cycle and due for a pause by the middle of the year. From a duration point of view, we began month long as global consensus was a pivot just around the corner. Bond yields got to multi month lows before consistent messaging from global central banks pushed back on pricing. The Active Bond Fund entered an underweighted duration position at around 3.00% in 3y bonds. We took profit and at month end we saw bonds now oversold and momentum turning so we have entered an overweight position of around 0.3 years. The portfolio was also positioned for flatter curves which was additive to alpha. Primary issuance was very busy in the debt capital markets space and was very well absorbed by real money managers such as JCB, as well as reports that European central banks had been consistent buyers of Australian spread paper, as well as ongoing demand from domestic balance sheets. The JCB Active Bond fund was active in the primary issuance deals, and we added to our ESG product through the EIB 4.2% 2028 and the Asian Development Bank 2026 Gender Bond. The portfolio was positioned with an overweight position through semi governments and supranational spread product which performed well over the month.