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- The US Federal Reserve implemented its third rate rise in 2017, while the US tax reform bill was enshrined into law prior to year-end; US credit enjoyed a positive month in performance terms
- US credit outperformed European markets as European credit was hit by a rates sell off
- Emerging market corporate credit had a positive end to the year with oil & gas and metals & mining credits benefiting from the positive global economic growth backdrop and higher oil prices
US credit markets ended the year on a positive note, rebuffing pressure from rates as the Federal Reserve implemented its third 25bps interest rate hike for the year. This tops an attractive, above-coupon return year for both the investment grade and high yield segments of the market. In the month, investment grade significantly outperformed high yield with the cyclical sectors of media, retail and telecommunications among the strongest performers, supported by the strong economic backdrop. Meanwhile high yield returns were dominated by the performance of energy credits which were buoyed by continued higher oil prices amid elevated seasonal demand and the ongoing inventory limits underpinned by OPEC. Economic growth continued apace while the employment rate also remained solid; December non-farm payrolls rose more than consensus estimates. The progress of the US tax reform bill dominated newsflow during December. The much-hoped for US tax reform plan finally came to fruition after tax legislation was passed by both the Senate and House of Representatives and subsequently signed into law by President Trump. The tax cuts are expected to boost the US economy, although the near-term impact on credit markets is less certain as the cap on interest deductibility may weigh on certain issuers. Longer term, the cap on interest deductibility may lead to less leveraged issuers than in the past.
Despite an overall strong year for European credit markets, with total returns higher than many predicted, a small amount of that return was lost in December. This was more pronounced in the investment grade segment of the market which suffered more from the rates sell off than did high yield, which is less rates sensitive. Nevertheless, while credit market performance was slightly weaker, the region’s economic recovery continued to gain momentum; the European Commission consumer confidence indicator hit its highest level in 16 years. Spain’s political crisis continued after regional elections resulted in a narrow victory for the three pro-independence parties in Catalonia, although without any clear direction for a new and cohesive regional government. While the news had a negative impact on equity markets, credit and bonds remained largely unscathed. Brexit negotiations remained high on the agenda of both the EU and UK as the latter continued to work out its exit strategy from the common bloc. Among the most newsflow heavy corporate stories over the month came from Frankfurt-listed furniture retailer Steinhoff International, after accounting irregularities were exposed at the firm.
Emerging market corporates had a quieter end to the year, although still produced a positive return in December. On a regional basis, African and Latin American credits were the strongest performers while Asian and European corporates were slightly weaker. It was another solid month for higher yielding paper which outperformed investment grade. TMT and pulp & paper credits were among the best performers, boosted by idiosyncratic events. Metals & mining and oil & gas corporates also did well; oil and commodity prices maintained their price strength with copper hitting a four-year high, lifted by strong demand from China. December newsflow was largely dominated by Latin America. The Brazilian central bank cut interest rates to 7% in an effort to provide further economic stimulus as the country recovers from recession. Argentina also continued to make economic progress after controversial pension reform plans were passed as part of a wider strategy to reduce the country’s fiscal deficit. In Peru, President Kuczynksi narrowly avoided impeachment after admitting links to Brazil’s Odebrecht, the construction firm involved in the wide reaching Operation Carwash scandal. Colombia also faced some challenges during the month after S&P downgraded the country’s sovereign rating one notch to BBB-, citing economic growth concerns. Meanwhile in South Africa, deputy president Cyril Ramaphosa triumphed in elections for the leadership of South Africa’s ruling ANC amid hopes his increased influence could signal a move towards more market-friendly policies for the country. Risk in Turkey also eased somewhat after the US resumed visa services for Turkish nationals following a three-month suspension.