Global credit markets in review: May 2021 | Calamatta Cuschieri

Markets summary

Sacrifices borne by governments, businesses, and the public at large, to mitigate the spread of the coronavirus pandemic, certainly leaving a harsh impact on the economic landscape, is at last coming to fruition.

While restrictions on movement and a coronavirus vaccination drive, now seemingly well-underway in the developed market world, proved crucial curbing the spread of the deadly virus, monetary and fiscal support allowed economies to rebound from worrying lows.

Selective economic data points continued to depict a more benevolent scenario.

Eurozone factory activity growth surged to a record high in May, boosted by surging global demand. Notably, Eurozone Manufacturing PMI stood at 63.1, above April’s final figure of 62.9. Eurozone consumer price inflation accelerated to 2 per cent year-on-year, up from 1.6 per cent in April, and above market estimates of 1.9 per cent. Services, previously posing a drag on the single currency bloc, pointed to the strongest pace of expansion since June 2018. This, following the easing of pandemic-inflicted movement restrictions.

Annual inflation rate in the U.S. soared to 5 per cent in May, from 4.2 per cent in the previous month and well above market forecasts of 4.7 per cent, amid a surge in demand as the economy reopens, soaring commodity prices, and supply constraints. Aggregate business activity in the U.S., as measured by the Composite Purchasing Managers Index (PMI) - an indicator of economic health for manufacturing and service sectors, rose to 68.7 in May from 63.5 in the previous month - signalling the sharpest upturn in private sector output since data collection began.

Albeit the improvement in economic data, increasing optimism, credit markets were largely constrained by concerns that upside data surprises may ultimately result in more persistent inflation, possibly forcing central banks to bring about a premature end to the growth rebound.

Sovereign yields

Euro area: Although initially pointing higher, extending on the upward trajectory witnessed in recent months as the economy and coronavirus immunisation gained traction, European sovereign yields have generally over the month, remained flat.

The European Central Bank’s (ECB) dovish stance towards the end of month, led Euro area investors scrambling for the safe haven of government bonds. Spurring such yield curve moves is the debate whether the ECB is going to slow asset purchases in its June 10th policy meeting or in subsequent meetings, as the economy recovers back from its steepest recession in decades.

In May, the 10-year German Bund, closed the month 2bps higher than the previous, at -0.19 per cent.

U.S.: Having sold-off since the beginning of the year, U.S. Government bond yields were little changed in May. However, they closed the month slightly lower which in turn conditioned the investment grade space.

The benchmark U.S. 10-year Treasury yield, previously revolving below the 1 per cent barrier at the beginning of the year, closed the month 3bps lower than the previous, at 1.59 per cent.

Corporate credit market

In May, the performance of corporates within the investment grade space (the highest quality bonds as determined by credit rating agencies) was mixed. Meanwhile, high yield issuers (more speculative bonds with a credit rating below the investment grade tranche), delivered gains.

U.S. corporate credit outperformed its European counterparts.

U.S. investment grade, previously conditioned by a rapid rise in Treasury yields, generated moderate positive returns for the second successive month, of 0.68 per cent. Meanwhile, European investment grade – the worst performer for May generated marginal negative total returns.

Over the stated period, European and U.S. high yield names generated total positive returns. European and U.S. high yield names returned 0.17 and 0.25 percent, respectively.

Albeit doubts surrounding the coronavirus pandemic in EM countries remained - with nations battling against a rise in infections and struggling to get a vaccination programme up to speed, EM high yield generated total positive returns, as investors continued to fetch more attractive yields. In May, EM high yield corporates generated 0.93 per cent. The second successive month of gains, following a negative first quarter of 2021.

Credit outlook

We believe that a coronavirus vaccination programme being well-underway along with the reopening of economies, shall indeed continue to pay dividends. Generally, a geographical diversion remains. Economic data, previously showing signs of weakness as the recovery remained constrained by the health crisis, shall further improve, as the resumption to normality continues to pick up speed.

Undoubtedly, focus remains on the degree of inflationary pressures and subsequent move from central bankers, to-date seemingly willing to maintain an accommodative stance. We maintain our view that recent price pressures were fuelled by transitory anomalies and namely to date, by supply disruptions.

The ECB maintained the elevated pace of its asset purchase programme in its June meeting, despite a likely economic rebound and price pressures rising.

Albeit the unexpected rise in annual inflation fuelled expectations that the Fed may commence a tightening, we believe that the Fed will ultimately wait for more concrete economic indicators, not susceptible to a low base case, to provide visibility on the economic recovery path.

We remain constructive within the high yield space, and more specifically on sectors that should continue to benefit as we further approach normality. We are also of the belief that given the economic dispersions, European high yield will be more resilient to its peers, given any amplified curve moves.

Moreover, the idea of improved credit metrics, as the economy recoups, might pose an opportunity for very diligent bond picking in selective credit stories, which hold the possibility of a rating upgrade. Indeed, as we had indicated in our previous reports, we commenced experiencing this notion with companies seeing an improved trend in metrics.

In conclusion, market disruptions may offer pockets of opportunities, with selective sectors being good candidates for portfolio positioning.


Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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