Insight Investment
February 16, 2018
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Navigating tight valuations: Quarterly fixed income and currency review and outlook / January 2018

  • Global growth and accommodative monetary policy supportive
  • Tightest global credit spreads since financial crisis
  • Valuations make for a trickier environment in 2018

Global investment grade credit markets performed over the final quarter of 2017 in much the same fashion they had throughout the year. Amid low risk market volatility, global credit spreads reached their tightest levels since the global financial crisis (see Figure 4).

The continuing synchronized global growth upswing and benign inflation backdrop continued to support the market. Gradual efforts to normalize central bank policy left markets unfazed. A key announcement came from the European Central Bank, which said it would taper its monthly purchases from €60bn to €30bn beginning in 2018, but the impact on credit was softened when ECB President Mario Draghi stated the bank “will continue buying sizeable quantities of corporate bonds”. In the US, the Federal Reserve began slowly reducing its balance sheet, and as was widely anticipated, hiked policy rates in December.

The credit rally paused briefly in November, partly driven by negative idiosyncratic earnings results from high yield names. These included a UK chicken supplier, brick-and-mortar retailers and an Italian construction company. Global M&A activity in the US was also a reminder that idiosyncratic risks remain a theme.

However, credit spreads went on to steadily tighten into year-end, with the passage of the US tax reform bill in Congress acting as a further global tailwind.

Looking ahead, market fundamentals look strong. Default rates will likely be around record lows and the global growth picture will likely be positive for corporate earnings. Furthermore, the potential for rising government bond yields is unlikely to threaten credit markets as long as moves remain orderly and contained. But 2018 will likely be a trickier year for credit investors than 2017. With valuations at material tights, the risks of a market correction could be asymmetric, particularly in an environment in which technical support from central banks will reduce at an accelerating rate. Stock and sector selection and the ability to hedge credit risk exposure could be key drivers of returns.

Peter Bentley
Head of UK and Global Credit

Read the full report here .

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