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Credit resilient ahead of key central bank meetings

With August out of the way, it is safe to say that all asset classes have come out of the gruelling summer months relatively unscathed. Pretty uncharacteristic for this time of the year. Credit and equity markets across both sides of the Atlantic have maintained solid ground during July and August as the leading central banks have, either directly through their communications or indirectly through their respective committee members that both the US Federal Reserve and the European Central Bank are willing to pounce, if and when economic and market conditions permit.

To say that both leading central banks (and their economies) are at different crossroads is an understatement to say the least. In the US, speculation is rife as to when the next increase in interest rates will materialise.

Prior to last Friday’s jobs report the market was pricing in a 40% likelihood of a September rate hike and well over a 60% chance of a rate hike coming in the December FOMC meeting. Today, chances of a September rate hike have reduce to just over 35% whilst the probability of a December rate hike remained intact.

True, chances of a September rate hike could have been dented by the disappointing jobs report release on Friday, which indicated that the US economy added fewer jobs than had been previously indicated.

But this is merely just one data point which yes, has fallen below expectations, but does nothing to harm the trajectory of the next move by the US Federal Reserve. It can eventually result in the Federal Reserve to postpone a September rate hike, but I am of the opinion that a December rate hike is pretty still much on the cards.

On the other hand, we are on the eve of what is expected to be yet another key and pivotal ECB meeting. If you recall well, the March ECB meeting (the run up to it, the outcome and the aftermath) pretty much shaped the European market for most of the second quarter of 2016.

The announcement of additional stimulus to the market was well received and saw credit markets (both investment grade and high yield) continue to grind tighter and tighter, and are today testing the lows witnessed in the 2014/2015 credit market rally. Sovereign bonds, particularly core European sovereigns reached record lows and have their benchmark 10-year bonds and most of their yield curves in negative territory.

So what is so special about Thursday’s ECB MPC meeting and what is all the fuss about? Following the monetary stimulus European markets have received over the past couple of years and the much needed support which the market needed (QE inevitably kept prices supported, particularly within the fixed income space), and following the remarkable performance European credit has had so far to date, investors begin to ask themselves: what incremental value (in terms of upside potential) could we or should we expect in the event of yet another market friendly ECB meeting this week?

Clearly, the market is expecting yet another fresh wave of support. The shape, size or form of additional measures so far is unknown, but what is key is the message and the accompanying tone of ECB’s Mario Draghi at Thursday’s press conference. It is already known to investors that at such low levels of interest rates, current valuations in European credit markets appear to be stretched, to say the least, and the downside risks by far outweigh any upside potential.

The benefits of holding on to European credit (in the event of additional stimulus measures) need to be highly stressed on Thursday.

Anything short of what investors expect could be the right opportunity (or excuse) for markets to sell-off as investors could be seeking to protect remarkable Year-to-date performances on their portfolios, yes why not, so early on in the year.

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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