During its September statement the FOMC highlighted that the labour market resources remain underutilised and that rates would remain on hold for a considerable time after QE tapering. US GDP for Q2 was revised up to 4.6% from 4.2% on an annualised basis. Initial jobless claims, mortgage applications and ISM continue to improve but house prices remain under pressure. US equities had a positive quarter with the S&P500 up 0.6% despite being down 1.6% in September. US 10 year bonds rallied to 2.3% during August as investors rotated into safe haven assets amid rising geopolitical risksin Russia, Ukraine and the Middle East. This was short-lived as bonds retraced to end the quarter at 2.5%. During Q3 US CPI fell to 1.7% year on year from 2.1% with PPI ending September at 2.3% year on year from 2.4% in July.

In Europe, weak economic growth and deflation fears remain prevalent with Mario Draghi confirming that the ECB was ready to do more quantitative easing. European bonds rallied aggressively with German 10 year bonds rallying by 30bps whilst Italian and Spanish 10 year bonds rallied 50bps. German 2 year bonds ended the quarter at -8bps from 3bps. This also initially increased investor appetite for emerging market assetsbut was soon reversed as rising geopolitical risksresulted in the JP Morgan EMBI returning - 2.4% for September and -1.7% for the quarter. The SARB remained on hold after expressing a more dovish tone with 6 out the 7 participants voting for no hike. Q2 GDP data came out at 0.6% on an annualised basis lower than market expectations of 0.9% due to strike activity in the mine and steel sectors. The SARB revised down its 2014 growth estimates to 1.5% from 1.7%. Deputy Governor Kganyago highlighted the need for policy normalisation as a slow reaction to rising US rates would mean further pressure on the currency. The reserve bank finds itself in a stagflationary bind with the currency being the deciding factor in testing the reserve banks inflation targeting credibility. SA inflation eased to 6.4% for August from 6.6% in May largely due to decreases in food and oil prices.

The weaker exchange rate pass-through has been muted given lacklustre consumer demand. Core inflation ticked up to 5.8% from 5.6% whilst PPI moderated to 7.2% from 8.1%. The rand traded weaker against the US dollar and on a trade weighted basis on the back of a worse than expected trade deficit of -R16.3bn. The R186 sold-off by 36bps to end the month at 8.36% given the softer currency. Foreign demand for local bonds decreased during September with non-residents selling R12.2bn and year to date purchases standing at R2bn.

South Africa's country risk premium, the yield spread of South Africa's dollar-denominated bond over US treasuries, was 20bps wider over the quarter at 2.0% after reaching a high of 2.8% at the end of January. The All Bond Index returned 2.2% for the quarter with the 12+year and 3-7 year indices performing the best by delivering 2.5% and 2.0 respectively. The yield curve flattened during the quarter as the R214/R186 spread moved from 70bps to 61bps. The Fund is underweight duration relative to the ALBI with overweight positions in the 3-7 year and 12-20 year areas. The underweight position is mainly in the 20+ year area due to increased funding risk.We will reduce the underweight position as 20+ year yields rise to more attractive levels. Yield enhancement continues to be mainly via bank and State Owned Enterprises (SOE) exposure in both the bond and cash markets. We continue to hold credit to take advantage of the additional pick-up in yield.

The Fund underperformed the ALBI over the quarter due to the yield curve flattening and the underweight duration position.

In the US, Janet Yellen delivered a bullish statement with officials forecasting an improved unemployment rate but indicated that the current economic climate warrants lower rates for longer. The Fed tapered by the usual $10bn to $35bn per month with core PCE failing to reach the 2% level but did show signs of improvement. US equities extended their gains as the S&P500 was up 1.9% for the month whilst US 10 year bonds weakened by 7bps to close at 2.54%. CPI increased to 2.1% from 2.0% year on year whilst PPI decreased to 2.0% from 2.1% year on year. Emerging markets continued their strong performance with the JP Morgan EMBI returning 0.7% for June and 5.6% for the quarter.

Over the quarter German 10 year bonds rallied by 30bps whilst Italian and Spanish 10 year bonds rallied by 45bps and 56bps respectively. This continued bullish trend is stemming from lower default risk in the Euro-area peripheries, accommodative monetary policy from the ECB and possible quantitative easing. In SA, S&P downgraded the sovereign rating to BBB- from BBB with a stable outlook whilst Fitch reaffirmed the BBB rating but changed their outlook to negative from stable. The reasons for the downgrades were labour unrest, lacklustre growth, a high current account deficit, increased funding requirements, volatile portfolio flows and electricity shortages.

During June the 5 month long AMCU strike ended but NUMSA subsequently announced an indefinite strike from 1 July which will result in 220,000 workers downing tools. The rand traded firmer during Q2 due to increased risk appetite from foreign investors and a better than expected current account deficit but still depreciated by 0.4% on a nominal trade weighted basis and 1.0% against the US Dollar. Due to a stronger currency and weak growth numbers the SARB did not hike rates at its May meeting but was concerned with higher inflation expectations. SA inflation increased to 6.6% for May from 6.0% in March largely due to increases in food and transportation. The exchange rate pass-through has been muted given lacklustre consumer demand. During June core inflation ticked up to 5.6% from 5.5% whilst PPI decreased to 8.7% from 8.8%.

Over the quarter the R186 rallied below 8.0% given the strong currency and foreign investor appetite but retraced towards 8.5%. Foreign demand for local bonds continued during June with non-residents buying R11bn, with year to date purchases standing at R20.2bn. South Africa's country risk premium, the yield spread of South Africa's dollar-denominated bond over US treasuries, narrowed by 20bps over the quarter from 2.0% to 1.8% after reaching a high of 2.8% at the end of January. The All Bond Index returned 0.95% for June and 2.46% over the quarter. Over the quarter the 3-7 year and 7-12 year indices were the best performers delivering 2.9% whilst the 1- 3 year area of the curve was the laggard delivering 1.8%. The yield curve steepened during the quarter with the R186/R209 spread widening from 49bps to 63bps but flattened 12bps during June.

During June the fund purchased R186 put options with a 9% strike to reduce risk in this area from any reversal of the carry trade. The Fund is slightly underweight duration relative to the ALBI with an overweight position in the 12-20 year area and an underweight position mainly in the 20+ year area due to increased funding risk. We will reduce the underweight position as 20+ year yields rise to more attractive levels. Yield enhancement continues to be mainly via bank and State Owned Enterprises (SOE) exposure in both the bond and cash markets. The Fund underperformed the ALBI over the month due to the yield curve flattening but outperformed over the quarter.

The Fed continued their recent trend to taper by $10bn at their March meeting and updated its guidance on when the central bank might start raising short-term interest rates. US equities sold off following the announcement and Janet Yellen's suggestion that the Fed could start raising short-term interest rates "six months" after it ends the bond- buying program. This meeting highlighted that the Fed has moved to a more qualitative approach from its previous quantitative guidance approach. US retail sales, initial jobless claims and unemployment continue to improve, but mortgage applications are taking strain due to higher treasury rates. CPI and PPI decreased to 1.1% from 1.6%and 0.9% from 1.2% YoY respectively. Over the quarter the equity market was 1.3% higher whilst US bonds ended the month 30bps lower to close at 2.72%.

Emerging markets continued their rally after their January sell-off. The JP Morgan Emerging Market Bond Index returned 1.3% for March and is up 3.7% for the quarter. German 10 year bond yields rallied by 36bps whilst Italian and Spanish 10 year yields rallied by 83bps and 92bps respectively over the quarter. This is due to the lower default risk in the Euro-area peripheries coupled with deflation risk. In SA the MPC did not hike interest rates but remained hawkish. The decision was relatively close with 3 members calling for a hike and 4 calling for no hike. Gill Marcus cited the currency as the major risk which is currently dominated by external forces.

The rand was stronger than its January highs which improved the SARBs core inflation forecast from 5.8% in 2014 and 5.9% in 2015 to 5.6% for each respective year. The R186 continued to rally ending the month at 8.4% from last months' 8.5% as foreigners increased their emerging market bond and equity exposure. Over the quarter however, the R186 sold-off by 17bps. The rand remained volatile over the quarter trading between 11.50 and 10.50 and depreciated by 1.2% on a nominal trade weighted basis, but appreciated 1.8% against the US Dollar. SA inflation ticked up from 5.8% in January to 5.9% in February. This was largely due to the cost-push inflation pass-through from a weaker exchange rate into food and transportation. The pass-through has been muted given lacklustre consumer demand.

Core inflation remained steady at 5.3% indicating subdued demand-pull inflation whilst February's' PPI increased to 7.7% from January's 7.0% as producer margins continue to get squeezed. Foreign demand for local bonds increased during the month with non-residents buying R7.7bn, although foreigners are still sellers of R6.4bn year to date. South Africa's country risk premium, the yield spread of South Africa's dollar-denominated bond over US treasuries, narrowed by 27bps over the quarter from 2.24% to 1.97%, but did reach a high of 2.80% at the end of January. The All Bond Index returned 1.8% for March. The 12year+ index delivered 2.2%, followed by the 7-12 year index at 1.7%. The 1-3 year area of the curve was the laggard delivering 1.0%. The yield curve steepened with the R157/R186 spread widening 17bps.

The Fund remains slightly overweight duration relative to the ALBI with overweights in the 3 year and 12-20 year areas as the market remains too bearish, pricing in aggressive interest rates hikes over the next year. The underweight position is mainly in the 20+ year area due to increased funding risk. We will reduce the underweight position as 20+ year yields rise to more attractive levels. Yield enhancement continues to be mainly via bank and State Owned Enterprises (SOE) exposure in both the bond and cash markets.

We continue to hold credit to take advantage of the additional pick-up in yield. The Fund outperformed the ALBI over the month given the overweight duration position.