Corporate Credit Snapshot – 31 August, 2018

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  • Global fixed income returns were mixed with US fixed income outperforming its European counterparts and Emerging Markets (EM) negatively impacted by increased volatility
  • European and EM credit markets underperformed during August, impacted by contagion from Turkey and underlying concerns around the upcoming budget negotiations in Italy
  • Risk-on sentiment in the US was supported by generally solid corporate earnings and outlooks, no defaults of loans or bonds, and limited spill-over from EM volatility
  • The Federal Reserve meets in September and according to Bloomberg is largely expected to increase the fed funds rate.  Starting in October, the Federal Reserve will also increase the rate of quantitative tightening, by allowing $50 billion of maturing Treasury and Agency bonds to roll off balance sheet without reinvesting the proceeds thereof

US
Fixed income returns were broadly positive led by US Treasuries and followed by high yield, investment grade, and leveraged loans.  August was a month that can be characterized by investor sentiment that was, paradoxically, both risk-on as well as safe haven-seeking.  Risk-on sentiment was supported by generally solid corporate earnings and outlooks, no defaults of loans or bonds, and limited spill-over from Emerging Market volatility.  Developments in Turkey and Argentina, however, likely contributed to investors seeking safety in Treasuries, hence their strong outperformance.  From a technical perspective, high yield benefitted from limited new issuance (lack of supply) and inflows (positive demand) into the asset class.  The Federal Reserve meets in September and, according to Bloomberg, is largely expected to increase the fed funds rate.  In October, the Federal Reserve will also increase the rate of quantitative tightening, by allowing $50 billion of maturing Treasury and Agency bonds to roll off balance sheet without reinvesting the proceeds thereof.  While reduced demand for longer dated bonds could put upward pressure on longer rates, it remains to be seen what impact this tightening could have on the longer end of the curve given strong institutional demand for the asset class.

Europe
European credit markets underperformed their US counterparts during August, impacted by contagion from Turkey and underlying concerns around the upcoming budget negotiations in Italy. In particular, the European financials segment of the market weakened amid fears of European bank exposure to Turkish and Italian assets. Issues in Turkey continued on the back of the ongoing dispute between Turkey and the US, rising inflationary pressures, and central bank inaction, resulting in a further sell off in the lira. Italy’s decision to start initial budget discussions surprised the market and sent Italian bonds yields sharply higher. While appetite for Italian bonds continued, with steady demand for new issuance at month end, the paper was priced at higher yields due to increasing risk awareness amongst investors. Indeed, Fitch cut the country’s credit outlook from stable to negative at month end due to concerns around the country’s high debt levels. The ECB meanwhile continued preparations for trimming its balance sheet against a backdrop of relatively robust growth in the Eurozone, despite headwinds from global trade wars, although the bank was keen to emphasise the need for caution.

EM
Emerging market (EM) corporate debt experienced a more volatile month, with idiosyncratic events in a number of countries weighing on sentiment over the period. Performance by sector and country was mixed, while by rating, investment grade outperformed high yield.  From a regional perspective, Asia was the strongest performer while Eastern Europe was the most notable laggard. In Latin America, Brazil and Argentina made headlines over the month. In Brazil, the election campaign continued to gain momentum, with the first round scheduled for October. However, there were signs that market-friendly candidate, Geraldo Alckmin, was lagging behind in the polls. Meanwhile, following a prolonged period of uncertainty, former president Lula, who is currently imprisoned on corruption charges, was officially barred from participating in the elections. Events in Argentina moved into the spotlight towards month end following an unexpected announcement by President Macri surrounding the country’s funding agreement with the IMF. The ensuing confusion resulted in a significant devaluation of the peso. Turkey’s currency also continued to move lower due to ongoing concerns about the strength of the country’s economy, fears of rising inflation, and the ongoing dispute with the US regarding a detained US citizen and the tariffs imposed as a result.