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US fixed income returns were flat to strongly positive for the month of August, having recovered from a challenging first half of the month. By month-end, US Treasuries outperformed, followed by investment grade corporates and then high yield. Corporate credit came under pressure in the first half of the month largely due to geopolitical concerns (North Korea/US tensions) and a supply-demand imbalance – specifically, significant new issuance as issuers wanted to get deals done in advance of the quiet that settles in August. The supply-demand imbalance shifted in the second half of the month as new issuance slowed considerably during the typical end of August lull. While we have heard some concerns about US high yield investment outflows, the market continues to find strong technical support as managers find it challenging to buy paper due to the shrinking size of the US high yield market overall (companies have been refinancing in Europe instead of the US or deleveraging and getting upgraded to investment grade). The world’s central bankers assembled in Jackson Hole in August and made largely benign statements. September is anticipated to be a busy month with both the Federal Reserve (Fed) and European Central Bank (ECB) scheduled to make announcements. Given solid fundamentals, the main risks to the market are, in our opinion, geo-political (North Korea/US) and Washington politics.
European fixed income markets posted positive returns for the month, led by high quality government bonds. The Bund rallied (yields down) as investors became less concerned about the impact tapering will have on markets as it is expected that Quantitative Easing (QE) will wind down slowly in the face of a rising Euro (the rising Euro is expected to make it harder for inflation to move to its long term target). Compared to rates which boasted strong positive performance, credit was largely unchanged to only slightly higher. Despite strong economic data, credit was partly held back by equity markets which took a pause after a strong rally, and also by the lack of progress by the US administration on its major policy plans and increased geo political risks. The market became very quiet over the last two weeks of August with little in terms of new issuance and fund flows. Supply so far this year has been healthy and met with strong demand. As investors’ current appetite for bonds focuses on the shorter dated maturities, issuers are matching this demand with shorter dated maturities. Most of the additional supply is coming from non-Euro based companies issuing in the Euro market in order to diversify their funding base. We do not expect the European Central Bank (ECB) to make major announcements during this week’s policy meeting, but rather to explain some details about their expected tapering plans in October.
Emerging Market (EM) corporates (both high yield and investment grade) generally outperformed their developed market counterparts. August represents the 9th consecutive positive month for EM credit, the last negative month being the November 2016 “Trump Tantrum”. It appears that investors that sold in November have been buying back EM ever since. Global economic data continued to gain momentum with global GDP expanding at the fastest pace in seven years even as inflation remained muted. In fact, 3 countries that have historically struggled to bring inflation under control (India, Indonesia and Colombia) all cut interest rates 25 bps in August. Given this positive economic backdrop, cyclical (oil/gas, metals/mining) sectors and LATAM outperformed. In political news, North Korea/US tensions continued to rise throughout the month. In Brazil, the government voted against the continued investigation into Temer, suggesting that Temer would now stay in office until next October’s general election. This should hopefully allow him to concentrate on passing much needed reforms. Finally, in Argentina the government coalition had a strong showing in the legislative primary elections, beating the Peronist party. We believe this is confirmation that the reform process has been accepted by the population.