Yet another remarkable performance for global credit markets in July as the flight to yield in a low volatility environment persisted in the first month of the third quarter of 2017.

And credit markets marched on yet again. Spreads ground even tighter to year-to-date lows. From European High Yield to US High Yield to Emerging Market debt markets. Monies continue to flow in the asset class, and there does not seem to be any signs of abating yet. With European High Yield registering a 0.93% gain during the month, followed by a 1.15% rally in US High Yield markets, investors must begin to wonder how much lower can spreads go, or rather, how tight must valuations get for there to be a slowdown in all this jubilance.

With earnings season in full swing and two key central bank meetings out of the way, credit markets threaded along and have been anything but volatile heading into the lull of summer market activity.

We are aware that investors could get ahead of themselves, particularly in Europe as the strong set of earnings releases so far and the string of debt portfolio enhancements of corporate bond issuers since the start of the year have placed issuers on a better footing, whilst in the meantime, spreads continue to tighten.

In addition, with the imminent reduction in the ECB’s quantitative easing programme, we do not exclude investors anticipating Draghi’s next move and moving the market before any official announcement, in their attempts to pre-empt any potential sharp uptick in benchmark yields.

With benchmark yields rising, the hunt for yield could abate, particularly within that segment of investors who stepped down the ratings ladder for an improved yield. This could ultimately mark the start of a correction in high yield markets. Not only in the single currency region but also spill over across the Atlantic.

Another possible scenario could also be bond issuers rushing to bring fresh bonds to the market to lock in financing costs at current low levels in anticipation of rising financing costs. If this results in an inundation of bond issuance, we could well witness a repricing in both the primary and secondary markets towards the latter part of the year as the increase in supply could dent investor’s hopes for any grind tighter in spreads from this point forth.

The US Federal Reserve kept interest rate in check and left door open to begin unwinding its balance sheet possibly as early as August, but was nonetheless dovish on the inflation front as the headline rate reference was changed to ‘running below 2%’ from ‘somewhat below’.

Meanwhile, recent data suggests that governments and companies from emerging market economies, nations have issued in excess of $400 billion worth of euro and dollar bonds in the first seven months of 2017; the fastest rate on record.

This comes to no surprise as ultra-loose monetary stances in Europe and the US coupled with an ever-weakening US dollar has compelled investors to search for yield beyond the developed world, by venturing into higher-yielding assets such as emerging-market bonds. Emerging market debt posted a satisfactory 0.85% during the month of July and are up by 5.92% year-to-date.

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, views and opinions provided in this article are 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.