Corporate Credit Snapshot – 31 July, 2019

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  • Global market fixed income returns were positive for the month, led by European government bonds like UK Gilts and German Bunds, and European investment grade corporates and emerging market (EM) high yield
  • Fixed income benefitted from global central banks indicating a likely return to monetary easing which (coupled with weaker economic data) pushed rates lower across the curve
  • Germany’s manufacturing sector continues to weaken, largely as a result of trade wars, BREXIT, generally reduced demand, and lower European GDP prints
  • Inflows into fixed income have been robust as investors are generally of the view that rates are trending downward

US
US corporate credit returns were positive for the month, led by loans, then investment grade corporates and high yield. It was largely a coupon-like month for the US high yield market. The Federal Reserve (Fed) meeting at month-end was top of investors’ minds for most of July. Investors had largely anticipated a rate cut, the only question being the magnitude of the cut and the forward guidance. The Fed cut rates by 25 basis points, but forward guidance did not guarantee future rate cuts, disappointing the market. Inflows into fixed income have been robust as investors are generally of the view that rates are trending downward. New issuance resumed at a brisk pace as investors looked to take advantage of low rates and refinance. Earnings season began in earnest with approximately 20% of S&P 500 companies reporting by month-end. Earnings were generally positive. The US Senate was expected to pass—and President Trump is expected to sign—a budget deal that increases the debt ceiling and thereby prevents spending cuts, a government shutdown, and/or a potential default on US debt.

Europe
European fixed income rallied in July, led by European government bonds like UK Gilts and German Bunds, and investment grade corporates. European high yield and loans also generated a positive, albeit lower return compared to their longer duration counterparts. Duration rallied as the European Central Bank (ECB) indicated a likely return to monetary easing which (coupled with weaker economic data) pushed rates lower across the curve. In its most recent statement, the ECB changed language in the forward guidance on policy rates to a more dovish stance indicating a cut (to the deposit rate) is likely in September. The market is now expecting a large easing package that will likely include a reopening of the ECB’s quantitative easing program as the ECB attempts to combat weaker European economic data. Germany’s manufacturing sector continues to weaken (source Reuters), largely as a result of trade wars, BREXIT, and general reduced demand, and European GDP prints have been lower. Inflation expectations continue to also drift lower. The result of this move in rates is that several countries’ bonds are now firmly in negative territory (eg: Germany, Switzerland). According to the Financial Times, banks like UBS plan negative interest rates for wealthy clients, thereby “passing the cost of central banks’ lower-for-longer stance to depositors”. While the intention of the ECB’s stimulus measures is to encourage investment into the economy and risk assets (thereby stimulating growth), the actual impact remains to be seen. In the immediate term, we have seen flows into credit (both high yield and investment grade) as investors seek an alternative to deposits. Christine Lagarde was nominated as the president of the ECB and successor of Mario Draghi. She is generally expected to embrace Mr. Draghi’s accommodative policy.

EM
Emerging market (EM) corporate bonds continued to deliver positive performance in July, with credit markets broadly benefiting from looser monetary policy. EM central banks moved ahead of the US Federal Reserve with rate cuts implemented by countries including South Korea, South Africa, Indonesia, Ukraine and Russia. Turkey also cut rates by 425bps, far ahead of the 25bps expected by markets. The country’s economic rebalancing continued with its current account balance shifting from deficit to surplus in June, further benefiting from US President Trump’s removal of any threat of sanctions. South Africa announced a further capital injection into state-owned utility Eskom. The capital injected over the next two years is expected to put pressure on the sovereign fiscal budget, which is adding to downgrade pressure from rating agencies. Within Asia, China released second-quarter GDP numbers which were in-line with expectations. Social unrest continued in Hong Kong with further protests against the Chinese government, while North Korea tested short range missiles.