One of the recurring themes we have been talking about over the past couple of years has been the robustness of credit markets in general, particularly the riskier part of the spectrum such as High Yield and Emerging Market credits, and the remarkable performance registered since mid-2016.

Credit markets posted yet again another remarkable performance in 2017 and the initial trading sessions of 2018, as there seems to be no signs of the global search for yield abating for the time being. Interest returns across both regions were the greatest contributors to total returns in 2017 whereas so far, price returns are taking centre stage.

Economic data has been resilient, both in the Eurozone and in the US, and this was translated into yet another positive string of corporate results in the second half of 2017. PMIs remain robust, unemployment low, and inflation has increased too albeit, has stalled somewhat of late. The European Central Bank forecast for inflation for 2018, 2019 and 2020 remained intact.

Investors were welcomed by positive trading screens in the initial trading sessions of the year as risk-on mode remains ever so present. All risky assets have rallied so far this year. From High Yield bonds to peripheral bonds, to a strengthening euro to emerging markets, but equities have been the clear winners so far, particularly emerging market equities.

The economies of European sovereigns have been performing extremely well, case in point of late has been Spain, which was upgrade to A- over the weekend, which resulted in a rally in Spanish government bonds. On the flipside, the safe haven government bonds particularly in the US and Germany bore most of the brunt of the risk on mode, which ensued in a widening of benchmark yields.

However, what is interesting to note is that credit spreads have not tightened despite the increase in benchmark yields and increase in bond supply on the primary market, and this is mainly attributable to the fact that the quench for yield has not yet been satiated and remains intact.

The flurry of cash waiting to be invested has absorbed the temporary rise in benchmark yields and has managed to withstand short term price corrections as investors laden with cash have viewed these blips as an opportunity/excuse to put money back to work, thereby keeping bond prices supported.

Over the past 12 months or so, emerging market credit has been the clear winner within the fixed income space, with the performance witnessed in EM bonds very difficult to ignore, and even more so, harder for an investor not to be participating in.

Emerging markets have offered a pick-up in yield and spread terms on a like for like basis in comparison to similar rated and dated High yield issuers, and with a flat yield curve in developed economies, monies are expected to continue to flow into emerging market credit.

The biggest questions bond investors continue to ask themselves is how long will bonds continue to rally and, when yields eventually begin to rise, will the move be sharp enough and not give them enough time to exit the market due to the vanishing of bids on the market?

Tough question but it seems apparent that, now more than ever, markets are paying attention to central banks’ reminders and warming to that fact that rates will not remain low forever. In the coming weeks/months, we continue to expect the ECB to move further towards exiting its quantitative easing programme (QE) through an announcement of another reduction in the pace of its asset purchases.

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.