Corporate Credit Snapshot – 31 December, 2018

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  • Global risk assets experienced significant declines this December – with the exception of Emerging Market high yield – on Federal Reserve (Fed) tightening, political uncertainty and weaker economic data
  • Global fixed income generally performed as expected with governments and investment grade corporates attracting assets (and rallying in price) in a flight to quality and outperforming all other segments of the bond market
  • While the Federal Reserve did raise rates in December, markets (as per Bloomberg data) are now forecasting a 0% probability that the Fed raises in March
  • While it is difficult to forecast a recession, valuations have certainly become more attractive as investors question economic strength

US
Risk assets experienced significant declines this December on Federal Reserve (Fed) tightening, political uncertainty and weaker economic data. It is worth noting that while US high yield and loans posted their worst monthly returns of the year, equities (S&P 500) declined 4 times as much for the month. dropping more than 9%. In this risk-off environment, fixed income performed as expected with Treasuries and investment grade corporates attracting assets (and rallying in price) in a flight to quality and outperforming all other segments of the bond market. While the Federal Reserve had clearly telegraphed that it would raise rates at the December meeting, an equity market swoon in early December and public remarks from President Trump pressing the Fed not to raise rates gave some investors the (false) impression the Fed might pause. While the Fed did raise in December, markets (as per Bloomberg data) are now forecasting a 0% probability that the Fed raises in March. Political uncertainty in the US (border wall, government shutdown, trade tensions with China) as well as abroad (Brexit and Italy) also pushed investors out of risk assets. Finally, weaker economic data has some investors questioning whether an economic slowdown will turn into a recession. While it is difficult to forecast a recession, valuations have certainly become more attractive as investors question economic strength. Whether valuations become even more attractive, stabilize, or tighten depends largely on whether the markets see some resolutions to political issues, Federal Reserve direction, and the strength of the economy.

Europe
Themes that have dominated markets over the past quarter – geopolitical concerns, fears surrounding weakening economic growth, US trade policy, Brexit, falling oil prices etc. continued to weigh on sentiment into year end. The equity markets appeared to take the brunt of the impact in December while government bond yields rallied in an investor flight to quality. European credit market performance followed a similar pattern where returns were bifurcated by rating with positive numbers from investment grade due to a rally in rates (credit spreads continued to widen but the positive move in rates more than offset this). High yield was weaker as investors moved away from the ‘riskier’ end of the credit spectrum. While furore between Italy and the European Commission appeared to resolve, the UK’s planned withdrawal from the EU hit further roadblocks as the UK Prime Minister delayed a parliamentary vote on the government’s proposed deal. As expected, the European Central Bank (ECB) confirmed it would end its monetary stimulus programme after nearly four years of asset purchases, although it will continue to reinvest maturing bonds. Nevertheless, this was against a backdrop of signs of economic weakening after the Eurozone composite purchasing managers’ index fell to a three-year low while France’s private sector also contracted, impacted by the disruption from recent civil unrest.

Emerging Markets
December marked a positive end of the year for emerging market (EM) corporate fixed income—quite the opposite of the turmoil in EM equity markets. From a regional perspective, Europe and Asia were among the best performers while Africa and the Middle East were weaker. By sector, pulp/paper and real estate performed well, while weaker returns came from oil/gas and metals/mining. Turkish corporates were one of the stronger performers during December as the country’s economic situation continued to improve with the current account surplus benefiting from the weaker lira and economic rebalancing. South African bonds also benefited from signs of economic improvement after the economy emerged from recession in the third quarter. Ukraine’s sovereign debt was upgraded by Moody’s which also changed its outlook from positive to stable; the country further benefited from an end to martial law amid reduced tensions with Russia. There was good news for Russian corporates after the US Treasury’s Office of Foreign Assets Control (OFAC) notified Congress of its plans to end sanctions on beleaguered companies EN+ and Rusal, which had been penalised due to their ownership by Russian oligarch, Deripaska. In Latin America, Mexican corporates performed well as the market appeared to take positively the budget announced by newly-elected President Obrador, which appeared fiscally prudent and provided the President some much-needed economic credibility. Moving to Asia, China’s National Development and Reform Commission announced guidelines to corporates issuing domestic bonds, relaxing the rules and benefiting Chinese property companies, in particular, who have been under refinancing concerns. The move is part of a wider drive by the government to reduce companies’ reliance on bank lending. Early-month trade talks between China and the US at the G20 Summit also eased tensions somewhat after they agreed a 90-day delay to any further tariff increases subject to further discussion.