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Credit – where do we go from here?

Believe it or not, we’re already almost in the mid-way mark in October and we’ve entered the final stretch of 2016, with credit markets having had their better share of what was a rollercoaster ride in the first few months of the year.

The rally which ensued post beginning of year sell off saw a lot of winners within the bond market asset class, not least US high yield, but this does not mean that it was a smooth joyride, and neither does it mean that the last few months are expected to be a piece of cake… far from it.

The uncertainty about the imminent future of global capital markets, bond markets in particular, is making investors jittery and reluctant to commit risk positions in an aggressive manner heading into 2017, especially given the good run witnesses to date, which could partially explain the exacerbated corrections in credit of late.

The lack of significant macro news has, in part, helped key central banks to delay any form of commitment to any form of monetary policy and/or asset purchases changes.

The Bank of Japan recently announced a new unconventional monetary policy tool for controlling its yields curve, which is aimed at keeping its benchmark 10-year note at 0 per cent.

September started relatively encouraging but the lack of new policy responses from the ECB and the edginess in the run-up to the Fed meeting generated a concerted bout of weakness. The recovery in risky assets in the aftermath of the Fed’s decision to keep rates on hold was short-lived as concerns over Deutsche Bank continue to weigh on market sentiment.

Early last week in Europe, speculation that the ECB may taper its bond purchases in anticipation of the scheduled end of the famous QE program in March 2017 caught the market by surprise and sent yields in Europe markedly higher, with chatter that the €80 billion monthly program could be reduced in tranches of €10 billion per month.

We are of the opinion that the market’s over-reaction was somewhat premature and the bearish response has been overdone. Having said that, we are aware that data coming out of the Eurozone has persisted on its positive trajectory. But, the ECB is nowhere close to achieving its inflationary and economic growth target.

Meanwhile, we expect trading activity in US credit market trading to remain choppy in a tentative over the near term as investors continue to digest the possible ramifications of the outcome of the November presidential election as well as the momentum Q3 earnings seasons is expected to add to what can be considered to be an already fragile market as valuations appear to be pricey to say the least.

The December rate setting meeting is expected to be the highlight for global credit markets in Q4 as all leading central banks are expecting to take cue of developments in the US before un-leashing their monetary ammunition any further.

We expect Q4 to be the most challenging of quarters this year for credit, as we are aware that a large number of asset managers worldwide will be seeking to protect year-to-date performance.

To top it all up, mixed economic data points, key central bank meetings, the price of oil, a weaker sterling, weakness in the European banking sector and an endless list of ongoing events is expected to keep everyone on their toes. What is certain is that at these levels, there is no longer any margin for error.

The key is not to be too bold at this time of the year and own a diversified portfolio of goo solid names, as there clearly are no longer any bargains in the secondary bond market.

Disclaimer: 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. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. 

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