Credit Markets: November 2021 in review

Markets summary

The coronavirus pandemic have, since first detected in the Capital of Hubei Province - Wuhan, dominated news headlines. It caught the world by surprise, altering life patterns and dictating economies path forward. Financial markets inevitably felt the pinch.

Efforts by central banks in the form of stimulus support, and governments, through mitigation measures to reduce the spread, vaccine coverage, and fiscal support, improved the scenario both from a health and economic perspective. However, in recent weeks a surge in coronavirus cases, possibly due to a seasonal effect which may probably contribute to a bigger outbreak, was witnessed. In fact, Europe is experiencing a surge in coronavirus infections, to levels not seen in months.

A new mutation: the Omicron variant, emerging from southern Africa, augmented fears that countries, owing to the variants’ unprecedented set of genetic mutations may once more be engulfed with infections. Conclusive findings on such emerging mutation, due to its relatively recent discovery, is thus far unavailable. That said, the repercussions, both from a health and economic viewpoint, the latter dependant on the ensuing course of action by governments to mitigate the spread and to ultimately avoid overwhelming hospitals, remain unclear. Vaccination programmes and distribution of boosters - a third dose which shall further increase immunisation against the virus, shall undoubtedly aid to mitigate the impact.

As concerns over the possible negative effect the Omicron variant may have on global economy rose, yields of European sovereigns and U.S. Treasuries, previously portraying an improved and thus more stable economic scenario, and possible stimulus tapering, reversed. This, notwithstanding the change in the U.S. Federal Reserve (Fed) rhetoric, which turned increasingly hawkish over the course of the month.

The risk off-mode was reflected in the corporate credit market. Investment grade credit (the highest quality bonds as determined by credit rating agencies) headed higher, while high yield corporate credit (more speculative bonds with a credit rating below the investment grade tranche) closed the month lower. European investment grade and high yield outperformed its U.S. counterparts.

Sovereign yields

Euro area: As economic activity maintained a robust pace and ECB President Christine Lagarde failed to push back against hawkish market bets pricing in two rate hikes by the end of 2022, European sovereign yields headed higher. The downward moves envisaged were however largely reversed in November.

A risk-off mode due to; increased uncertainty stemming from a resurgence in coronavirus infections and eventual re-imposition of mitigation measures, and expectations that the ECB will take longer than most central banks to normalize monetary policy, drove yields of European sovereigns, lower, halting the uptick.

Earlier in the month, ECB policymakers acknowledged that a decline in inflation, hovering close to, but below, 5 per cent may be slower than earlier anticipated, adding that the central bank must not overreact by removing stimulus too quickly.

The largest drop in sovereign yields since early March came towards the end of the month as investors sought safety after a newly-identified coronavirus variant was spreading. To mitigate the spread, several European countries announced a temporary ban on flights from South Africa and neighbouring countries. Resultant to rising concerns surrounding the possible economic impact, money market participants no longer expect an increase in the ECB deposit rate in 2022, even though the Eurozone’s inflation rate has risen to a record high in November.

Yield of the 10-year German Bund, closed the month 24bps lower at -0.35 per cent from -0.11 per cent at the end of October. Bond yields of sovereigns within the bloc’s periphery – those which offer a premium over Germany’s negative yielding debt, dropped at somewhat similar, yet lower pace.

U.S.: U.S. Treasury yields have over the month of November retraced some of the upward moves witnessed towards the end of Q3, then heading higher as the market’s focus turned to rising inflation and the prospect of the withdrawal of monetary policy support.

In the month, markets grappled with both the emergence of a new coronavirus variant and a change in the Fed’s rhetoric which over the month became increasingly hawkish. Chair of the Fed, Jerome Powell, noted that the strength of the U.S. economy coupled with the threat of persistently higher inflation meant a swifter tapering of asset purchases.

During a congressional hearing, Chair of the Fed Jerome Powell signalled his support for a quicker withdrawal of the huge asset purchase programme. While acknowledging the current risks to the U.S. economy, Powell noted that the price increases that propelled inflation had spread more broadly across the economy in recent months, heightening threats of higher inflation. Also, Powell added that it was no longer appropriate to describe price pressures as “transitory”.

The benchmark U.S. 10-year Treasury yield, closed the month 11bps lower at 1.44 per cent.

Corporate Credit Market

In November, a rise in coronavirus infections which led to the re-introduction of mitigation measures and emergence of the new Omicron variant, all-in-all punctured sentiment. A risk-off mode was witnessed. Investment grade, subsequent to the moves witnessed at sovereign level, notably European sovereign yields and Treasuries, headed higher, outperforming high yield corporate credit, which generated total negative returns.

Over the stated period, European investment grade, the best performer for the month saw a gain of 0.16 per cent while U.S. investment grade generated marginal returns of 0.09 per cent. In the more speculative segment, European credit outperformed its U.S. counterparts, registering a loss of 0.57 per cent against a 1.02 per cent loss. EM high yield, the worst performer for the month, lost 1.84 per cent.

U.S. high yield remains the best performer on a year-to-date basis, with a total return of 3.42 per cent.

On a sector basis, the scenario was largely negative. Generally all sectors saw spread widening, with industries sensitive to reopening and a recovery falling more on fears posed by the newly discovered variant which may ultimately result in lower demand.

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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