Credit Markets: October 2021 in review

Markets summary


Consequent to an increased level of money supply through unprecedented monetary stimulus, an uptick in inflation, thus far proving to be supply rather than consumer driven, was warranted. Whether such price increases are transitory or else persistent is yet an outcome ought to be determined.

The sustainability of inflationary pressures has in October continued to be quite a debate. Largely, investors are of the view that temporary price pressures could well be embedded in more long-term expectations and last even as the growth from reopening fades away. A surge in energy prices, due to an increase in both demand and limited capacity, have made matters worse, amplifying fears around longer-lasting inflationary pressures.

Supply bottlenecks - in our view the key source to inflationary pressures, is a phenomenon we’ve been witnessing in 2021. Disruptions worsened by a second coronavirus wave, a blockage in the Suez Canal earlier in March, port closures in China, and capacity limitations, are seemingly persisting. Supply issues along with increased demand for goods, led to higher input costs, which were ultimately translated onto customers.

In the month, inflationary pressures have led markets to price in a faster pace of policy tightening from central banks across the world. Notably, the U.S. 10-year benchmark Treasury yield hit a high of 1.7 per cent over the month of October. Larger increases in shorter-dated yields caused interest rate curves to flatten.

Sovereign yields

Euro area: European sovereign yields have in October pointed higher, continuing to reverse some of the downward moves envisaged since the end of Q2 2021, as economic activity maintained its recent robust pace and European Central Bank (ECB) President Christine Lagarde failed to push back against hawkish market bets that were pricing in two rate hikes by the end of 2022.

During the month, the single currency bloc continued to benefit from the release of pent-up demand, having come out of coronavirus-inflicted restrictions relatively late. Notably, yield of the 10-year German Bund, closed the month 9bps higher at -0.11 per cent from -0.2 per cent at the end of September. Bond yields of sovereigns within the bloc’s periphery – those which offer a premium over Germany’s negative yielding debt, rose at somewhat similar, yet higher pace. Italy’s and Spain’s 10-year sovereign yields rose 31bps and 15bps, respectively, over the month.

The governing council of the ECB held off making any significant moves in its policy meeting. The central bank left its key interest rate unchanged. In support of its two per cent inflation target and in line with its monetary policy strategy, the Governing Council expects interest rates to remain at their present or lower levels. Also, net asset purchases under the Pandemic Emergency Purchase Programme (PEPP) shall continue with a monthly pace of €20 billion for as long as necessary to reinforce the accommodative impact of its policy rates. Asset purchases shall come to an end shortly before the bank starts raising its key ECB interest rates.

U.S.: U.S. Treasury yields have over the month of October continued to retrace some of the significant downward moves witnessed in recent months, then influenced by investors beginning to doubt whether economic data, notably the upticks in inflationary figures would continue to advance or else prove transitory. As the market’s focus turned to rising inflation and the prospect of the withdrawal of monetary policy support, yields rose back to similar levels seen at the first half of the year.

In October, investors awaited the Federal Reserve (Fed) November meeting and its policy direction going forward. Investors expected Fed Chair Jay Powell to announce a reduction in bond purchases.

Earlier, the Fed suggested that stimulus, notably asset purchases could start being reduced as early as November and possibly be wound up by mid-2022, earlier than initially anticipated.

The benchmark U.S. 10-year Treasury yield, closed the month 6bps higher at 1.55 per cent. The figure remains below high’s witnessed earlier this year, revolving above the 1.70 per cent levels.

Corporate Credit Market

In balance, October proved negative for the corporate credit market.

Investment grade bonds (the highest quality bonds as determined by a credit rating agency) were mixed, while high yield corporate credit headed lower.

Emerging Market (EM) high yield corporate credit continued on its downward trajectory, as the negative sentiment surrounding China, a key EM, remained. Regulatory actions in China were the initial trigger for market weakness in September. Market jitters were then amplified by the re-imposition of some coronavirus-inflicted restrictions leading to global supply chain disruptions. Moreover, worries about possible systemic financial system risks stemming from the potential collapse of Evergrande - the country’s second-largest real estate developer by sales, and an intense energy shortage in the country, also weighed on investors sentiment.

Over the stated period, U.S. investment grade, the best performer for the month saw a gain of 0.25 per cent while European investment grade lost 0.70 per cent.

In the more speculative segment, U.S. corporate credit outperformed its European counterparts, registering a loss of -0.18 per cent against a 0.64 per cent loss. Emerging Market high yield, the worst performer for the month, lost 2.27 per cent.

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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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