The European Central Bank (ECB) announced at its October policy meeting a tapering decision in line with market expectations. Specifically, President Mario Draghi stated that the ECB would reduce monthly asset purchases from €60bn to €30bn while extending the programme by nine months until September 2018. The ECB also announced it will reinvest the proceeds from maturing bonds purchased as part of the quantitative easing (QE) programme for an “extended period of time” although they gave no indication of the end date to this. Markets immediately reacted positively to this dovish news with the euro falling, core and peripheral government bond markets rallying and credit spreads on iTraxx CDS Crossover and Main tightening.
The dovish decisions made by the ECB were in line with our expectations. We believe QE, when considered in isolation, could continue to support demand for European investment grade and, to a lesser extent, European high yield corporate bonds. Corporate bond spreads could therefore continue to tighten further from current levels. However, the implications of QE cannot be looked at in isolation as other risks, especially on the geopolitical front, are present, including Italian elections in 2018, President Trump related headlines and Brexit negotiations, all of which could derail sentiment.
In our European investment grade strategy we are marginally long risk to our benchmark, reflected by a small underweight to European investment grade credit offset by an overweight to non-core areas of credit including European high yield, as well as smaller exposures in sterling and US dollar high yield, and EUR, GBP and USD investment grade credit. Despite continued positive flows into European investment grade credit, we are underweight the asset class as we believe valuations are rich and yields are low and unappealing. Our overall allocation to European high yield is a function of some high conviction, idiosyncratic credits. We also believe European high yield credit fundamentals are robust, with defaults low. The asset class appears further supported by positive risk sentiment in the market with equity indices at historical highs, and low net supply year to date.