In this video, Stephen Thariyan, Global Head of Credit, analyses recent moves in credit markets, particularly post Brexit, exploring the resulting impact and opportunities.
Corporate bond markets completed a u-turn in Q2, as sentiment improved on central bank actions and a rebound in the price of oil (the predominant cause of the sell-off in Q1). The reversal in sentiment led to strong total returns from the credit markets, which since the beginning of the year have delivered returns of around 4% in Europe, 7% in the US and the UK, and 9-10% in high yield.
The impact of the vote by the UK to leave the European Union (Brexit) has been dramatic in the markets, given that it was unexpected. The first order effect hit sterling very hard, the UK equity markets, particularly banks, and also government yield curves, on concerns for growth and expectations of central bank actions. The second order effects were unusual and interesting with credit markets rallying, equity markets quietening down while government bonds continued to rally.
However, as well as creating more concerns, Brexit offers opportunities. While investors worry about growth, government bonds and whether they should invest in risky assets, overall the opportunity probably lies in relative value. With little yield available from government bonds and expectations of central bank actions, current spread levels suggest a great deal of value in the credit asset class across both geography and rating.
Central bank action
Meanwhile, the European Central Bank (ECB)’s corporate bond purchasing programme (CSPP), has been effective in that bonds have been rallying, with investors looking to own bonds that could be purchased by the ECB. However, in an already somewhat illiquid asset class, this has helped exacerbate the liquidity issues within credit.
The Bank of England and the ECB have been swift in dealing with Brexit, addressing any liquidity issues by reassuring markets that they stand ready to help going forward. This is not surprising as they have been on the front foot for the past seven or eight years, altering the dynamics of who is buying what, when, where and why. This is likely to continue, and is probably being re-emphasised by Brexit.
The outlook for the markets remains interesting and unusual, not least because Brexit has added to the multitude of pre-existing concerns. While there is clearly relative value present in spread products across ratings and regions, Brexit is likely to add to the bumps in the road ahead. It only takes one particular concern about a security or an asset class, a movement in the price of oil (as we saw in January and February), or political tensions, for example, to have a dramatic adverse impact on the markets.
Right now there is value out there. Corporate bonds are going through different credit cycles depending on geography and there are plenty of places to be positioned in. Value versus government bonds is also present. We are now seeing some signs of increased liquidity with active buying and selling of corporate bonds, however, we await the third and fourth order effects of Brexit and the opportunities they present.