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The fixed-income market in January

Many market participants continue to question about the sustainability of the bond market in generating returns following years of gains. Some sort of skepticism is in place as to date we have a diverging monetary policy.

In the US the Federal Reserve (FED) is tightening its policy, while the European Central bank (ECB) in Europe maintained let’s say it’s loosening stance. In fact, in its last meeting it re-assured the market that it will revise upwards its stimulus if economic market conditions deteriorate. All in all, in January the bond market once again generated positive returns.

Europe

The long end of the sovereign curve upheld its declining momentum, as investors continued to offload their positions in line with improving economic data, as the market has now higher expectations that the ECB will tighten its policies going forward. In fact, the 15-year plus sovereign curve declined by 5.4 per cent, while short-dated issues, 1 year to 3 year sovereign bonds, declined marginally by 0.28 per cent.

In the month of January, the BOFA Merrill Lynch European High yield index registered a total return of 0.78 per cent. That said most of the returns were generated through interest returns, rather than price appreciation. In actual fact, technically speaking this makes sense as looking at spreads on high yield bonds these appear extremely tight.

In this regard investors are not getting paid for the risk being taken. Just to put things into perspective, the current yield offered to an investor on a composite of BB bonds with a maturity of 10-years is just 2.02%.

Thus the minimal upside in terms of price appreciation is more than justified. As I have opined in other previous writings, in my view the potential downside risk for the high yield (HY) market is greater than any possible upside.

US

In the US treasury yields were conditioned by Trump’s chatter in his first days in office. In fact, the 10-year yield fluctuated from highs of 2.53 percent to lows of 2.33 per cent. On average the BOFA Merrill Lynch all maturity government index declined by 0.1 per cent.

On the contrary, HY US bonds continued to display gains with a monthly total return gain of 1.3 per cent, mainly driven by the attractive yields following the correction in November’s election.

Undoubtedly, the market has been pricing-in the expected three rate hikes in 2017 and thus market participants were happy to re-dip in at attractive levels.

On Wednesday, in its statement the Fed failed to indicate any further increased expectations in terms of rate hikes. However, it continued to acknowledge the fact that the labour market has continued to strengthen and that economic activity has continued to expand at a moderate pace.

Thus the non-indicative stance in terms of further rate hike expectations gave investors further comfort in holding-on to their risky assets and carry the trade.

Emerging Market hard currency bonds (EM)

Surprisingly enough EM bonds once again emerged as the best performing class amongst its peers with a monthly total return of 2.1 per cent. However, what is more interesting is the fact that if we had to dissect the said performance, 1.5 per cent was generated from price returns while 0.6 per cent were interest returns.

In my view, the price return movements are also justified given the fact that yields elsewhere are unattractive. In addition, over the month we noted a remarkable depreciation in the dollar against major EM currencies.

This makes it cheaper for EM corporates to service and re-finance their dollar denominated debt. Just to give you an idea in terms of figures, over the past month the Mexican Peso appreciated by circa 5.5 per cent, while the Brazilian real gained 2.6 percent.

In my view, going forward the fixed-income market sensitivity is highly correlated to increased market expectations on how monetary politicians will juggle their monetary stimulus.

However, in the US it’s also about fiscal implementation. Surely a continuous path of positive economic data will facilitate the tightening in monetary policy. Thus it is important that investors evaluate the asset classes which are more sensitive to any change in mainly monetary policies.

Disclaimer: This article was issued by Jordan Portelli, 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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