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Credit supply and CSPP to dictate spread movement in Eurozone

At present we have two relatively strong forces at play within the European credit markets. On one end, we’ve got the Corporate Sector Purchase Programme (CSPP), which is merely a form of Quantitative Easing (QE) by the European Central Bank (ECB) in the shape of the purchases of European Fixed Income Instruments on the Secondary Market.

That’s the demand part of the equation. To a lesser extent, we’ve also got the global search for yield (another contributor to demand formula) which is keeping bond prices supported and spreads anchored at low levels.

On the other hand, we have the issue of supply to contend with. Let’s face it, supply levels on the primary market has been relatively thin following the infamous Brexit vote just over 4 weeks ago, which in part has contributed, in part, to the spread tightening and rally in credit of late.

Over the past few summers, bond supply has been quite volatile, with muted volumes the past couple of years coming back from a flurry of supply in the previous two years, whereby almost €8bn of new bonds were issued. The Brexit was sure to bring with it a sharp drop in supply, but with the multi-tranche Teva bond issue last week and the multi-tranche Ineos bond issues today, we can safely say that demand for credit remains robust.

It is interesting to note however what bond issuers will be doing this summer. Earnings season appears to be in full swing, and after this week, the majority of issuers across both sides of the Atlantic would have announced their Q2 earnings, so in terms of momentum and sentiment, markets would have already grappled, picked up the pieces and started position themselves for the summer lull in trading activity.

With the ECB on track with its €8bn monthly bond purchases, and most likely having anticipated its August purchases, spreads have continued to tighten, and market conditions hence appear ideal for supply to be in abundance.

If the few primary issues are snapped up and the ECB is drying up liquidity, it may be difficult to source paper from secondary markets. If supply does not pick up this summer, this could ultimately squeeze spreads and yields even tighter.

We’ve got a number of economic data releases both in the Eurozone and the US to contend with this week, most notably inflation data and GDP numbers. The pinnacle of this week is expected to be on tomorrow’s FOMC meeting, with all eyes on forecasts and accompanying statements by the Fed on the next rate hike.

Analysts have reduced their forecasts for a rate hike this year; whilst we concur that the pace of rate hike is expected to slow, we do not rule out a rate hike in Q416. Investors will be closely monitoring Yellen’s speech tomorrow evening for additional clues on the trajectory of interest rates in the US.

The past couple of weeks was benign to the term structure of European credit with the long-term flattening trend at the longer end of the curve persisting, as the global search for yield continues. With spreads having rallied significantly of late, no one would be at fault for expecting some bouts of profit taking, however credit remains in good shape.

This week, we have the outcome of the bank stress tests to look out for, but the main event which could be a game changer for credit this summer is the Italian bank recapitalisation saga.

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.  

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