Credit in 2017 and the asset class have started 2018 in the same manner as last year.
Credit spreads have tightened even further and activity on the primary market have started at relatively elevated levels for this time of the year. One would have thought that credit would have fizzled at the thought of higher issuance and the thought of more bonds flooding the market, but this did not happen.
The market has so far absorbed the supply in its abundance, sending valuations higher and credit spreads, particularly the higher beta yielding segment of the asset class, markedly tighter.
There does not seem to be any imminent event, any particular market related move given the current prevailing conditions which have the potential of shaking credit markets and the positive tone that has lingered on from 2017. As we had stated towards the end of 2017, this comes as no particular surprise.
Economic data releases so far this year indicate that the Eurozone economy for starters is on the road to recover. Ok, inflation has stalled but the most recent ECB minutes give us reason to believe that QE will continue to be unwound and possibly have a rate hike by the end of the year.
Who knows? What is certain is that bondholders need to be aware of the ramification of a strong economy. Higher inflation per primis could result in bond yields in a rate higher than the markets forecast, together with tighter monetary policy. Last week we got a snippet of how fast benchmark yields could rise.
The primary market of new bonds started off the year strongly, with markets shrugging off fears that the distress of increasing supply could derail sentiment. In the US, credit also had a strong start to the year.
It was the higher beta sectors that have been the best performers to date, and that comes to no surprise given their high carry trade. The higher coupons allow those bonds at the riskier end of the asset class spectrum to withstand benchmark yields, and this is expected to be the trend for the first half of 2018.
With investors sitting on a lot of cash, analysts believe that investors have the financial prowess to keep yields suppressed and withstand any short term glitches in bond price movements. Sovereign yields do have the potential to widen credit spreads but we do not envisage that to happen anytime soon.
Disclaimer: This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is 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.