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- Global fixed income returns were mixed for the month, with US Treasuries, UK Gilts and German Bunds benefitting from a flight to quality and strongly outperforming corporate bonds
- Although US economic data was broadly positive, rising oil prices, an Italian political imbroglio, and renewed trade war fears led some investors to flee into the relative safety of US Treasuries and German Bunds
- The Italian political saga came to a head in mid-May after the coalition parties’ attempts to form a government collapsed, sending spreads on Italian BTPs wider and increasing fears of contagion. Global markets let out a sigh of relief once an Italian government was formed late in the month
- Dollar strength and rising interest rates in the US resulted in a number of EM central banks implementing rate increases to counteract the effects
US fixed income returns were mixed for the month, with US Treasuries benefitting from a flight to quality and strongly outperforming corporate bonds. Within US corporates, investment grade generated positive performance on the back of the Treasury rally while US high yield was slightly negative. Although US economic data was broadly positive, rising oil prices, an Italian political imbroglio, and renewed trade war fears led some investors to flee into the relative safety of US Treasuries and German Bunds. Global markets let out a sigh of relief once an Italian government was formed. US high yield technicals were generally supportive given a decrease in supply and net inflows. Issuance has lagged this year given higher rates and limited M&A, as well as the fact that many companies have already refinanced themselves over the last few years. We have noticed that, recently, many companies have preferred to finance themselves in the loan market given solid investor demand for loans. We have also seen an increase in upgrades, particularly of BB rated issuers, further reducing supply. Investment grade issuance was the same as in the previous month but lower compared to the same time last year. Larger investment grade issuers have had less of a new need to access the market as they are repatriating cash from overseas. Inflows into investment grade were more modest than in prior months.
Political risk dominated European credit markets in May, weighing on investor sentiment. Longer-duration paper suffered, although credits at the short end held up relatively well. The Italian political saga came to a head in mid-May after the coalition parties’ attempts to form a government collapsed, sending spreads on Italian BTPs wider and increasing fears of contagion for the region as a whole. This was exacerbated by political issues in Spain, where Prime Minister Rajoy received a vote of no confidence on corruption charges. As a result, the high yield segment saw not only wider spreads, but also the withdrawal of three new deals from the primary market and reduced issuance overall. In the investment grade market, spreads also widened significantly and BBB rated credits, hurt further by late cycle concerns, were notably impacted. Indeed, primary issuance weakened across the board, or came with concessions in order to attract interest. The standout performance, however, came from European loans where issuance continues to be strong, supported by M&A activity. At the sector level, financials were particularly hard hit on contagion fears and the possible impact a destabilised Italy could have on bank balance sheets. Italian bank spreads in particular moved in tandem with the sovereign.
Emerging market (EM) corporate credit performance in May followed a similar pattern to the previous month with negative returns driven more by exogenous events including the return of US Treasury yields back to 3% and political risk in Italy. By region, Middle East and Latin America put in the best performances as Europe and Asia fell. In Argentina, despite a difficult period of currency decline, the government and central bank continued to work on solutions to shore up the country’s economic reforms. These included a bailout plan with the IMF and an interest rate increase to stem the decline of the peso. The country also received a boost of confidence by a large asset manager who purchased $2.25bn of government bonds. Performance from Brazil was weaker as the country was impacted by strike action. Dollar strength and rising interest rates in the US resulted in a number of central banks implementing rate increases to counteract the effects, including two rate hikes in Indonesia, the aforementioned rise in Argentina, and one from Turkey. Eastern Europe felt the contagion effects of the Italian political crisis, with investors concerned about the impact the potential of a potentially more euro-sceptic government could have on the Eurozone as well as on the wider region as a whole.