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- Central bank actions dominated credit markets in October resulting in a mixed return environment. With markets pricing in a more hawkish Federal Reserve, US rates increased and the benchmark 10-year US Treasury yield surpassed 2.4% for the first time since March
- In Europe, the central bank announced its asset purchase program would be extended at least until September 2018, stepping down the additional purchases from €60bn to €30bn a month
- European high yield and investment grade credit delivered strong positive returns ahead of those in the US, boosted by the European Central Bank’s gentle tapering plan
- Emerging market credit spreads continued to grind tighter against a solid risk-on backdrop and positive global growth outlook
Hopes for US tax cuts and activity surrounding the US Federal Reserve (Fed) were the two key themes influencing US credit markets in October. With markets pricing in a more hawkish Fed, rates increased and the benchmark 10-year US Treasury yield surpassed 2.4% for the first time since March. With higher rates a headwind for fixed income, it was more of a ‘coupon clipping’ type month for US high yield; while returns were positive, there was slight capital loss. In terms of asset class performance and as a reflection of this change in environment, investment grade and high yield performed in line, while loans, with their floating rate characteristics, outperformed in anticipation of rising rates. From a technical perspective, new issuance was reasonable and priced at fair value as evidenced by bids after issuance. A large proportion of new issuance proceeds continue to be used for refinancing purposes, which is limiting growth in the size of the high yield market. However, during October the par balance outstanding remained stable as fewer rising stars left the universe for investment grade. October also saw the start of third-quarter corporate earnings season. Results so far have largely been acceptable with no major positive or negative surprises.
The European Central Bank (ECB) meeting towards month end was the main theme dominating European markets in October with expectations that Draghi would provide an update on the tapering plan for quantitative easing in 2018. This proved correct as Draghi announced the ECB would continue its asset purchase program at least until September 2018, stepping down the additional purchases from €60bn to €30bn a month. However, it is estimated that around €15bn a month of maturing current ECB holdings will need to be reinvested, effectively keeping monthly purchases at €45bn per month for another 11 months, after which we will likely see further tapering. Moreover, the ECB reiterated that the short-term deposit rate will not change from the current level of -40bps until tapering is well-concluded. The market rallied strongly on the news, further fuelled by weaker-than-expected inflation data. Also dominating headlines, the governing party of Catalonia attempted to break free from Spain. Nevertheless, a lack of support for independence amongst the Catalans resulted in the Spanish government dissolving the current Catalan parliament and calling for new elections at year end. Expectations are that the pro-independence party will lose its majority. Meanwhile the leader of the pro-independence party left the country; charged with sedition, he is not expected to return. Markets broadly shrugged off this political spectacle.
October was another positive month for emerging market corporate credit; spreads continued to grind tighter against a solid risk-on backdrop and positive global growth outlook. Higher-yielding, less US Treasury sensitive names produced the strongest returns as investors sought out yield, while investment grade lagged. By sector, energy and commodity related credits, notably in Latin America and Africa, were boosted by higher oil and metals prices. Oil (Brent Crude) reached US$60 per barrel by month end, buoyed by strong demand and comments from the OPEC-led consortium that it would extend output cuts beyond March 2018. At the country level, China’s 19th Congress dominated the early-month newsflow as Premier Xi Jinping was re-elected for another five-year term, providing stability to markets. Argentinean corporates gained on improving sentiment as Macri announced the start of much-hoped-for market friendly tax cuts, while Standard & Poor’s upgraded the sovereign one notch. In Venezuela, fears for a PDVSA default receded amid the government’s determination to meet its debt obligations and IMF indications it may inject some much-needed capital to bail out a country suffering from economic recession and political corruption under Maduro’s autocratic regime. At the other end of the spectrum, South Africa underperformed as its economic woes remained an ongoing theme following the dismissal of finance minister Gordhan in March. The government cut growth forecasts, leading to fears of further sovereign downgrades. Turkish credits were also weak as the EU continued to raise questions around the country’s EU accession.