Please click here to download the full report.
US fixed income returns were modestly higher this month-to-date, with US high yield outperforming, followed by investment grade corporates, loans and then Treasuries. The month started off quietly, given the 4th of July holiday, with limited new issuance and modest high yield outflows. As the month progressed, flows reversed themselves and became positive. Economic data was mixed with a strong payroll number at the start of the month and later, a modest uptick in unemployment and lackluster wage growth. In a reflection of this mixed economic data, Treasury yields drifted downward after peaking for the month on the same day the payroll figures were released – a sign that inflation fears have subsided. It appears investors are questioning whether the Federal Reserve (FED) will raise interest rates at their September meeting. In fact (according to Bloomberg), the market is now pricing in a much lower probability of the Fed raising rates in September. This is noteworthy given that the Fed has stated its desire to normalize policy and shrink its balance sheet. With the VIX (volatility index) at a 20+ year low, it appears that investors may be a bit complacent about risk – reflecting another Fed concern over the potential rise of asset bubbles. We believe that in the current environment of tight valuations, investors are well served by a manager who focuses on both generating returns while minimizing risk through a research intensive approach to credit.
European fixed income generated mixed returns with German governments declining (yields higher), high yield generating a modest, positive return and investment grade outperforming. After the sharp rise in yields toward the end of June, government bond markets stabilized in the first half of July and the investment grade credit market resumed its tightening trend. The high yield market underperformed on an excess return basis after a few sessions of negative fund flows and a heavy pipeline of new bond supply. Nevertheless, fund flows quickly stabilized for high yield and, indeed, in the investment grade market we never saw weakness at all. Investors are now awaiting the European Central Bank (ECB) council meeting later this week. We only expect a slight change in language and further updates on their thinking with regards to potential future tapering in September.
After a negative start to the month, Emerging Markets (EM) experienced a strong rebound. The volatility seen early in the month can be attributed to a variety of factors including rates, weaker/negative flows into the asset class, and commodity price volatility. Each of these factors, however, seems to have stabilized and thus reignited risk-on sentiment. Other noteworthy news came from China with stronger than expected data (Real GDP growth 6.9%). In Brazil, political noise continues; ex-president Lula’s receipt of a nearly 10-year jail sentence prompted a strong rally by reducing the possibility that he would run in 2018, while current President Temer still seems to be holding onto power for now.