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US fixed income returns were mixed for the month with high yield and syndicated loans generating positive performance and investment grade corporates and US Treasuries declining. September can be characterized as are turn to risk-on market sentiment as evidenced by the out performance of both high yield and US equities. Investor sentiment was bolstered by solid economic data and some of the negative headlines dominating the news (hurricanes/North Korea tensions) not being as severe as initially feared. Many investors are expecting a GDP lift in response to the hurricanes and rebuilding efforts. Both investment grade and high yield technical were strong given solid inflows. Issuance was robust with a wide range of companies coming to market, primarily for the purposes of refinancing. The Federal Reserve (Fed) met and announced that the Fed balance sheet reduction program would begin in October, but re-emphasized the slow and gradual nature of the balance sheet reduction process. The Fed intends to allow coupons and maturing bonds to run-off gradually without reinvesting the proceeds. Given the significant coupon income that is generated by the Fed’s investments, we will likely not see a material reduction in the size of the balance sheet until next year. The Fed also stated that it has lower edits long-term inflation outlook suggesting that longer rates are likely to remain lower for an extended period of time despite current expectations of a December rate rise.
European fixed income returns followed a similar pattern to the US, with high yield and syndicated loans generating positive performance and investment grade corporates and high quality sovereigns declining. European rates increased (prices down) and steepened over the course of September despite the European Central Bank’s (ECB) relatively dovish press conference earlier in the month. Credit spreads tightened in light of interest rates moving higher. While spread tightening was not sufficient to off-set the increase in rates in the investment grade market, high yield was able to generate a positive return. The high yield new issue market was very strong, partly as the market returned into full swing after the summer lull and partly due to strong issuance driven by Mergers and Acquisition (M&A) and Private Equity (PE) activity. The syndicated loan market also witnessed strong supply, while investment grade issuance was also robust with issuance ranging from repeat issuers to first time issuers both from the Eurozone and abroad. This supply has been met with robust demand with the ECB continuing to be a large and daily buyer. The ECB’s reduction in quantitative easing has thus far focused more on sovereign bond purchases and less on corporate bond purchases, where the central bank does not face the same capacity restrictions.
Emerging Markets (EM) generated positive returns for the month with high yield out performing investment grade in this risk-on environment. On a regional basis, LATAM outperformed while Asia lagged. Asia declined on the back of continued North Korea tensions and greater sensitivity to US Treasuries. On a sector basis, cyclical sectors like oil/ gas and metals/ mining out performed. Despite the Fed’s guidance that it would likely increase interest rates in December and begin to shrink its balance sheet, EM performed well. This is noteworthy as EM has historically been an asset class that is considered by some to beat risk if policy is tightened and liquidity removed. It was a busy month for central banks with Peru, Brazil, Russia and Indonesia all cutting base rates, while the Philippines increased their rates. We are witnessing a synchronized pick-up across the world in aggregate demand and trade, but this is not filtering through into inflation which remains subdued there by allowing central banks room to cut rates. S&P lowered China’s sovereign credit rating by one notch to A+, bringing it in-line with Moody’s (already reduced in May). The market ignored the announcement, with China sovereign bond prices remaining basically unchanged after the announcement. The EM asset class benefitted from continued inflows.