Brevan Howard Global commentary for the month ended August 31, 2016.
BH Global Limited (“BHG”) is a closed-ended investment company, registered and incorporated in Guernsey on 25 February 2008 (Registration Number: 48555).
Prior to 1 September 2014, BHG invested all its assets (net of short-term working capital) in Brevan Howard Global Opportunities Master Fund Limited (“BHGO”). With effect from 1 September 2014, BHG changed its investment policy to invest all its assets (net of short-term working capital) in Brevan Howard Multi-Strategy Master Fund Limited (“BHMS” or the “Fund”) a company also managed by BHCM.
Brevan Howard Global was admitted to the Official List of the UK Listing Authority and to trading on the Main Market of the London Stock Exchange on 29 May 2008.
Monthly Performance Review for Brevan Howard Global
The information in this section has been provided to BHG by BHCM.
BHG Monthly Commentary
The NAV per share of BHG’s USD shares appreciated by 0.10% and the NAV per share of BHG’s GBP shares depreciated by 0.14% in August 2016.
Brevan Howard Master Fund Limited (“BHMF”)
The NAV per share of BHMF Class Z USD shares appreciated by 0.01% in August. Interest rate trading generated small overall gains from directional and curve positions. Short positions in USD and EUR rates, and long positioning in the UK over the Bank of England’s interest rate cut, all contributed. Further small gains in interest rates were generated by basis trading in the US. Interest rate volatility trading generated small losses overall as gains from Sterling and European volatility trades only partially offset losses from long positions in Japanese volatility. Emerging Markets trading and Japanese swap spreads also were small detractors. In FX, losses mostly came from EUR currency trading as well as AUD and NZD. Gains from directional positioning in GBP and JPY partially offset these losses. Credit gains were generated across several trading books from positions in Asset Backed Securities as well as US mortgage agency debt, while equity trading lost money from Japanese equity volatility positions as well as US and European directional trading.
Brevan Howard Asia Master Fund Limited (“BHA”)
The NAV per share of BHA Ordinary USD shares appreciated by 0.21% in August. The main detractor of performance in August was due to the sell-off and flattening of the Korean interest rate curve. Offsetting gains in FX came from a combination of long positioning in volatility and gamma across a variety of G10 and Asian currencies as well as directional trading of USDJPY. Further gains came from volatility trading in US interest rates and to a lesser degree equity trading.
BH-DG Systematic Trading Master Fund Limited (“BHDGST”)
The NAV per share of BHDGST Class Z USD shares depreciated by 2.34% in August. In fixed income, BHDGST recorded losses primarily due to long positions in European and US bond futures as yields rose and prices fell. Improving US economic data and a more hawkish FOMC saw US bonds sell-off, while European bonds came under additional pressure from seasonally light QE buying from the ECB ahead of heavy Government debt issuance. Within short term interest rate futures, a short exposure to Canadian Bankers’ Acceptance notes and a long exposure to Eurodollar futures were both significantly reduced. Short Sterling was the only market to see risk increased, with a small addition made to an already sizeable long, taking exposure in this market to 27%/NAV. Long equity exposure to Asia and the US performed particularly well. With some key macro data recovering, particularly across the US & Emerging markets, and a growing interest across developed economies in alternative policy action via fiscal stimulus, risk assets were well supported. With volatility depressed amid a quiet summer and markets unable to break out of increasingly narrowing trading ranges, the extra yield offered by emerging markets attracted strong inflows after a period of protracted underperformance. BHDGST increased its net equity risk across all geographies in August to 80%/NAV. The biggest winners throughout the month were the NASDAQ and Hang Seng indices as 12bps and 10bps respectively.
Direct Investment Portfolio (“DIP”)
The DIP appreciated by 0.50% in August. The DIP generated the bulk of its profits in credit where smaller gains across ABS/MBS, corporate credit and agency trading contributed positively. Additional gains arose in GBP interest rates but the gains were partly offset by losses in JPY interest rates. In FX, gains from short exposure to GBP and JPY were offset by losses from long exposure to the EUR towards the end of August. In equity, a modest short exposure to European equity indices generated small losses. Long exposure to oil generated small gains.
Manager’s Market Review and Outlook
The information in this section has been provided to BHG by BHCM.
The highly anticipated August report on the labour market was mildly disappointing in each of its major components. Job gains slowed from the robust pace set in the prior three months. The unemployment rate was unchanged at 4.9%, which is the same rate seen at the beginning of the year. In addition, broader measures of labour market slack are approximately unchanged since the start of the year. The work week was revised down and ticked down further still. Finally, indicators of wage growth were soft and are showing only moderate gains over the last year. Putting those pieces together, it looks like the labour market is slowing a little rather than strengthening.
By contrast, the early readings on current-quarter growth have improved. The sizable inventory liquidation that subtracted from real GDP over the last year appears to be reversing, adding to growth noticeably. Apart from the inventory swing, the positive trend in consumption spending has been maintained, albeit at a slower rate than the outsized gain in the second quarter. Business fixed investment appears to be treading water, which is better than the outright declines in prior quarters. Residential investment also seems to be stabilising in the face of strong underlying fundamentals, including attractive mortgage rates, tight inventories, and positive demographic trends.
Inflation continues in a narrow channel. Core personal consumption expenditure inflation in August was 1.6% over the last year, the same rate as at the start of the year. Headline inflation has been stuck below 1% for most of the year, weighed down by past declines in energy prices that should lift over the next year.
The Federal Reserve (“the Fed”) tried in August to send a consistent message about the likelihood of further gradual rate hikes. Chair Yellen in Jackson Hole said the case for hikes had “strengthened” and Vice Chair Fischer didn’t rule out a faster pace of rate increases than present, discounted by market pricing. Other Fed officials were generally supportive of the thrust of the Chair’s message while being noncommittal about the exact timing. In Presidential politics, the national polls generally favoured Secretary Clinton over Mr Trump by a small margin as the campaign season entered its final stage. Since the campaign has been light on policy specifics, investors are left to wonder what the next administration will bring in terms of concrete policy initiatives.
Although growth has remained resilient up to the end of Q2, the UK faces considerable policy, and thus economic uncertainty on account of the June referendum vote to leave the European Union. GDP grew a firm 0.6% q/q in Q2, a touch stronger than the 0.4% increase in Q1. Whilst the Brexit vote is expected to weigh on the manufacturing sector, the depreciation in Sterling should support manufacturing activity and exports in general. Surveys on activity, which tend to lead GDP, have been somewhat mixed in recent months. The composite Purchasing Manager’s Index (“PMI”) rose 6 points in August to 53.6, after having fallen 4.9pp in the previous month. Current levels of the PMI suggest GDP should continue to grow (a better outlook than earlier expectations of a recession) albeit at a modest pace. Retail sales volumes continue to grow very strongly in recent months, reaching a pace of 4.8% on a quarterly basis. Whilst the fall in both retail surveys and consumer confidence would suggest retailing should moderate in coming months, it is possible that consumer spending is temporarily being boosted by the lower currency through tourism, especially if the rise in import prices is slow to feed through into retail prices. The housing market appears to have softened as well. House prices have moderated showing little growth in recent months; however there have not been any clear signs of the sharp fall that some commentators expected. Surveys on housing activity collapsed earlier in the year, but have picked up slightly returning to modest levels in the two months to August.
There has been little hard data on the labour market since the Brexit vote. The claimant count fell 8,600 in July and the unemployment rate recorded 4.9% in June, unchanged from the previous month. Moreover, employment grew at a robust pace of 2% y/y in June. However, there are signs that the labour market is softening; the composition of employment growth has been disappointing as it has been mostly come through growth in self-employment. Growth in full-time employees has grown very little in the three months to June. Moreover, surveys continue to suggest that employment growth should moderate in coming months. In addition, the claimant count has risen slightly in the first half of the year, despite the 8,600 fall in July. Core inflation ticked down 0.1pp to 1.3% y/y in July, however, headline inflation rose 0.1ppts to 0.6% y/y. Although the influence of the depreciation in the exchange rate has so far been modest, there are clear signs that the lower exchange rate will lift prices in the medium term. Surveys on prices have started to accelerate, reaching the highest levels in five years. Moreover, producer input prices rose 4.1% m/m in July, the largest monthly increase in the history of the series (starting in 1996). Over time, higher import prices and diminishing base effects can be expected to cause headline inflation to rise above the Bank of England’s (“BoE”) target of 2%.
The Prime Minister is expected to invoke Article 50 (the legal process in which the UK leaves the EU) in early 2017, although the exact timing remains unclear. As such, economic growth is expected to slow over the coming quarters as the uncertainty around the Brexit vote feeds into the economy. Due to projections of lower growth as well as downside risks to the inflation target in the longer-term, the Monetary Policy Committee (“MPC”) lowered the policy interest rate by 25bps to 0.25% in August and sought to increase the asset purchase facility by £70bn to £445bn in an attempt to bolster the economy. In August, the MPC suggested that if growth were to match the BoE forecast of 0.1% q/q in Q3, then further monetary policy easing would be needed in November. Given the rebound in the latest PMI, it is becoming increasingly possible that growth will surprise above the BoE’s forecast, implying that further easing may be delayed, if not halted.
Recent survey data have shown a loss of momentum of Eurozone economic activity. The final composite PMI for the euro area fell in August to 52.9 from 53.2 in July, led by a weakening of new orders, particularly in Germany and the manufacturing sector. Other key national surveys posted even more pronounced, sometimes non-linear falls, with the German IFO suffering a major setback which bodes badly for both the EMU and global growth outlook. While the declines may reflect some lagged reaction to the UK’s decision to leave the European Union, weakness in other major jurisdictions outside of Europe indicate a broader slowing of the global economy. Sluggish EMU growth is therefore likely to persist in Q3 after growth slowed to 1.2% q/q (annualised) from 2.1% in Q1. In turn, overall slower growth will continue to pressure countries more vulnerable to slowdown, let alone a recession, due to the unresolved legacy of the past crisis. In particular, any turmoil in the Italian banking system could also negatively impact the outcome of Italy’s constitutional referendum in November, to which Prime Minister Renzi has tied his political future.
The unemployment rate paused its downward trend and remained at 10.1% in July, down around 0.7pp on the year but still considerably above its pre-crisis average. Amid a still large output gap, extremely muted wage growth, lower NAIRU (“Non Accelerating Inflation Rate of Unemployment”) and exchange rate dynamics, inflationary pressures remain largely absent beyond the base effects that are expected to raise headline inflation closer to its current core rate by the beginning of next year. Economic and market conditions are unlikely to allow the ECB to “exit” from its asset purchase programme as early as March 2017, hence the Governing Council’s decision at the September meeting to refrain from extending the duration of its asset purchase programme is likely to be temporary and is poised to be revisited by the end of the year.
Chinese activity data for August showed tentative signs of stabilisation. The official PMI in July was better than expected with a 50.4 reading but the Caixin PMI fell. Hard data, from Industrial Production (“IP”) to trade, fixed asset investments and retail sales was better than expected by the consensus. However, this moderate improvement was mainly due to a higher number of working days in the month relative to the previous year. Indeed, measures corrected for this effect and / or for seasonality indicate that the Chinese business cycle peaked at the turn between the second and the third quarters and are now rolling over; a dynamic that is expected to continue in the coming months. Consumer Price Index (“CPI”) inflation fell sharply from 1.8% to 1.3% in August because of lower food inflation, undershooting consensus forecasts. Producer Price Inflation (“PPI”) deflation continued to abate, mainly because of the past increases in commodity and intermediate goods prices, a process which seems to have come to a halt in recent weeks.
The People’s Bank of China (“PBoC”) has maintained a neutral monetary policy stance; the 7-day repo rate jumped to 2.6% temporarily, but soon fell back to 2.3%. The PBoC has maintained a somewhat stable exchange rate for the past month, although with some volatility. Official FX reserves declined slightly in August, by US$15bn to US$3.18tn.
Japanese economic activity continued to trudge along. Real GDP rose 0.7% (annualised rate) in the second quarter. IP was flat in the latest month. The Shoko-Chukin survey of small and medium-sized firms and the Economic Watchers survey improved but remains at subdued levels. Altogether, the latest data do not suggest that the remaining output gap will be closed anytime soon.
Inflation trends also continued apace. Those trends continue to be the wrong way relative to the Bank of Japan’s (”BoJ”) expressed goal of pushing inflation higher. Twelve-month changes in the national western core rate fell 0.2pp in July, and the Tokyo measure decreased another 0.1pp to only 0.1% in August. Inflation expectations remained unchanged at 1.7% for a third month. The last time they were lower was at the start of 2013. The drag from the appreciation of the yen over the first half of the year will extend for a while longer, but will wane overtime. As a result, inflation will increase slightly, but there is nothing in the pipeline to suggest that inflation will come close to approaching the 2% target.
The September BoJ meeting appears to confirm fears that it has added to its mandate the support of banks, pensions and insurance companies. While an upward sloping yield curve is a symptom of a well-functioning economy, it is not a means to achieve it. At the meeting, the BoJ left its target for the short rate unchanged at -0.1%. It announced no changes to the pace of government bond buying and in fact said that in the future it will be flexible in its purchases in order to manage the shape of the yield curve. In remarks afterwards, Chairman Kuroda said that the current intention was to keep the ten-year rate around zero percent, where it is presently. Obviously, that’s no increase in monetary accommodation and seems designed to allow some support to longer rates prospectively. The BoJ made no changes to its stated commitment to achieve 2% inflation as early as possible, though its actions indicate otherwise. In that light, the Bank’s “inflation-overshooting commitment”, whereby the Bank commits to expand the monetary base until the year-on-year CPI rate exceeds 2% in a stable manner, is too distant to matter now.
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