October was a supportive month for risky assets as investors looked to take advantage of the more attractive valuations and of persistent expectations of abundant liquidity. The ECB meeting was pivotal in this respect indirectly confirming speculations that the European central bankers will soon have to resort to additional stimulus.
This was supportive for EUR credit markets and sovereign yields alike with the German 10 year bond dipping again below 0.5% and peripheral sovereign paper consolidating its rally. The 10 year Italian bond for instance has gained around 2% even though it gave up some of its gains in the last few trading sessions of the month.
Against this backdrop, the Investment grade (IG) corporate bonds also booked respectable gains as they benefited from lower benchmark rates and a gradual tightening in spreads. The longer maturities were the greatest beneficiaries, with the 10years+ notes gaining more than 3.5% during October (Bank of America Merrill Lynch EUR Corporate 10y+ Index).
Looking forward, the trend should consolidate as spreads (i.e. the premium over sovereign bonds) remain wide when compared to end-2014 (1.3% versus 0.97%) and the search for yield should intensify in anticipation of a new round of QE.
Meanwhile the EUR High Yield (HY) market rebounded from this year’s lows which pushed yields to multi-year highs. Total return year to date turned positive again, standing at about 2.5% (Bank of America Merill Lynch EUR HY Index) although the positive reading reflects the accrued coupons, with yields still below Dec-14 levels (5% versus 4.25%).
Whereas this suggests that further gains are to be envisaged over the next few months, I am mindful of HY bonds retesting this year’s low in yields (3.6%) anytime soon, as investors were disheartened by the downgrades in global growth and the spike in volatility. They might in turn wait for another reporting season to better judge the resilience of European corporates.
For this reason, as was the case in October, I continue to see the higher–rated end of the market as better positioned; this month, BB-rated EUR bonds booked a total return of 3%, versus 2.5% for Bs.
As regards the performance of USD credit, October was similarly positive, with the USD High Yield Indices recovering some of their earlier losses, particularly as investors started selectively picking up some of the commodity-related names. This week’s monetary policy meeting concluded with a more optimistic than expected statement as the Federal Reserve only briefly suggested possible side effects from global developments.
Whereas this caused a repricing of the US Treasury yields higher, it should be positive for US focused HY names as it reveals that the Fed is confident in the relative resilience of the domestic economic. One cannot exclude of course, the possibility of monetary policymakers being unreasonable in their assumptions and precipitating in their decision, which would of course be negative for credit. However, I think that this should not be the case as long as the Fed delivers on its guidance of only gradually lifting rates.
Indeed, the reaction of the markets so far suggests that a policy mistake is not a consensus view.
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