August 2022

“The dollar is our currency, but it’s your problem.”  US Treasury Secretary John Connally

The strength of the USD was at the forefront of market developments in August, as Europe’s energy woes and sclerotic growth elsewhere propelled the Greenback to levels not seen in twenty years.  This move in turn complicates the job of central banks already stretched to deal with sky-high levels of inflation and historically has created problems for developing economies.  Of course this is not the first time the USD level has been an issue.  It was in 1971, against the backdrop of the unravelling of the Bretton Woods exchange rate agreement and an end to gold convertibility that Secretary Connally uttered his famous phrase at a G10 meeting. This resulted in a new arrangement that saw a further 20% depreciation of the USD and the start of a prolonged period of volatility and economic turmoil.  Later on, in 1985 leaders crafted the “Plaza Accords” to curb excessive USD strength that grew out of the robust economic growth of that era and a steady 40% decline of the dollar ensued while equity markets flourished.  There then followed several similar periods following the downturns following the dotcom era and the global financial crisis, so it seems entirely appropriate that we have arrived at another period of currency stress coinciding with a potential inflection point in prospects for economic growth.  Just how far this stress extends of course remains to be seen and will be a function of data and official response.  But as in previous periods there will almost certainly be unintended consequences.

Otherwise, August was an eventful month with central bank tightening (BOE) and preening (everybody else) in a bid to telegraph future hikes.  Government bond markets were caught in bear flattening trends while equities were softer, with the SPX falling 4%.  European bank equities ended the month flat after having been up as much as 6%, as talk of a jumbo rate hike and signs of economic stagnation roiled markets late in the month.  Credit markets bifurcated, with mainstream bank AT1s trending lower while second-tier names rebounded from overly depressed levels.  Against that backdrop the fund’s A shares gained +2.97% with positive contributions mostly coming from our second-tier senior and Tier 2 holdings. Credit overall contributed +270bps to the gross performance of the fund while equities added +31bps.

Looking forward we enter September in full expectation of continued central bank tightening of rates.  How close we are to a pause will be driven by the data henceforth, with forward-looking growth indicators supplanting inflation measures for importance.  For Europe it remains difficult to see a pathway for a very politically sensitive ECB to embark on multiple, significant rate rises at a time where energy inputs are creating real economic headwinds and with member states divided on approach.  We continue to believe that we are well-positioned for this environment; our core holdings retain considerable fundamental value, while our overall exposure allows us to retain flexibility in the face of what will likely be a period of elevated volatility.