Credit once again posted a steady month, although it could have been much stronger were it not for the correction witnessed in the last week of January. In 2018, the asset class started in the same vein as it left off in 2017 - credit spreads have tightened even further as the upbeat global economy spurred risk assets on. The primary market too started at relatively elevated levels for this time of the year.

To date, the market has managed to absorb the supply in its abundance without causing spreads to widen, sending valuations higher and credit spreads, particularly the higher beta higher yielding segment of the asset class. True, we have seen an element of weakness towards the latter stages of the month, raising concerns of a bond sell off, but in essence, there does not seem to be any imminent event, given the current prevailing market conditions, which has the potential to derail markets any time soon.

The global economy data releases so far this year indicate that things are shaping up for the global economy to remain on a stable path, albeit with some expected glitches.

For example, recent ECB minutes suggest that inflation has stalled but give us reason to believe that QE will continue to be unwound and possibly have a rate hike by the end of the year. Higher inflation, together with tighter monetary policy, could result in bond yields in a rate higher than the markets forecast. Recent activity in the sovereign bond market gave us a snippet of how fast benchmark yields could rise.

The idea of a weak bond market, particularly within the investment grade space has been dwindling on investors’ minds for some time now. Treasuries and Bunds had, at least till the last quarter of 2017, been stubbornly hovering and anchoring at low levels, but now Bund yields over 0.7% and Treasuries over 2.7%.

To date, the rise in benchmark yields has been relatively muted and contained by central bank talk, however, market participants are aware that more monetary policy normalisation is in store in the US and Europe, and may add to investor’s woes about concerns about the longevity of the multi-decade bull market.

What is key at this stage is the way central banks manage to satiate investor expectations on one hand and control the possible spill-over to risk assets. This is going to be key going forward, both to global high yield bonds as well as emerging markets and equity markets.

Since the last quarter of 2016, emerging market credit and equities have been the winning asset class and region, 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.

How long will bonds continue to rally, and when yields eventually begin to rise, will the move be sharp enough to not give them enough time to exit the market due to the vanishing of bids on the market?

This is what is concerning the bond investors of late, and has resulted in a marked repricing in both the sovereign bond market and lower end of the credit spectrum. Tough question but it seems apparent that, now more than ever, markets are paying attention to central banks’ more hawkish tones and warming to the fact that rates will not remain low forever.

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.