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Give credit to credit

  • Investment Manager
  • Blog post submitted on 9th April 2019

Following dismal run risky assets endured during 2018, particularly the final quarter of the year, few would have imagined that the situation would have shifted in such a sharp manner as it did in the first 3 months of 2019. The market exuberance registered in Q1-19 had a contagion effect onto the first week of April. On a year-to-date basis, both credit and equity markets have managed to recoup a large chunk of the losses of 2018, quite a feat in such a short period of time. One might argue that the market still requires a notable rally from current levels to get back to pre-2018 levels but nonetheless, the strength of the rally so far in 2019 cannot be undermined.

More dovish than expected comments by central banks, particularly in the Eurozone and in the US, in their communication to the market in January, bolstered global market sentiment. This in part kept the US dollar trading in a range, with Emerging Market economies standing to gain from this. Equities and all assets class within credit across both sides of the Atlantic were the main beneficiaries from accommodative central banks. This coupled with encouraging developments on the Trade War front kept markets better bid for the majority of the trading sessions in 2019 to date.

The second quarter of 2019 took off where the first ended. Spreads tightening further and thereby extending the credit market rally. Yields on sovereign bonds, both of US Treasuries as well as those of core-European governments remained anchored at low levels, keeping benchmark yields low. What must be put into context is the level of supply credit markets had to endure so far. With the credit momentum gaining traction, credit issuers were once again enticed to test the primary markets – and so they have, in abundance. Credit continued to rally despite the marked increase in supply (in the form of new bonds on the market), and that is due to the fact that demand out-stripped supply. And that is because the retail and institutional investor remains cash rich and the global hunt for yield continues to prevail.

However, in the months ahead, bar any major surprises, we do not expect credit to continue to tighten the way it did on one end, nor is there any scope for spreads to widen from this point forth. The gradual grind of tightening is well on the cards so long as central banks maintain their accommodative stance, and global economic data and Q119 earnings seasons do not give markets a reason to be concerned about.

Having said that, the intricate factor behind this year’s spread tightening is not the benign outlook on the global economy but on the contrary- it comes on the back of central banks intervening to support the market over concerns on the health of their respective economies. This means that, following the recent run we’ve had, the risk-reward for credit is diminishing and upside potential is more than outweighed by any downside risk. But for the time being, we do not seem to be alarmed by the sharp rally, as long as there seemingly continues to be large amounts of cash to still be put to work.

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