Cautious on credit heading into Q218

If the first quarter of 2018 is anything to go by for the remainder of the year, then we are in for what could be a bumpy and painful ride in the next 9 months, which could end up in smiles or in tears. Credit has shown signs of frailty and weakness across the board, and from this point, the cracks can either become exacerbated or simply patched up. It’s anyone’s bet, that’s how fluid and delicate the situation is.

True, we did have bouts where credit rallied and showed its robustness. Lest we forget that credit started off the year on a strong footing, and it also showed signs of life as it grappled with already a number of market sell-offs and periods of weakness this year. But investors are beginning to get edgier than ever, and who can blame them. After all, credit markets have proved to be benign for investors over the years, and have managed to withstand crisis after crisis. Central Banks have also had their fair share of accommodating the markets and keeping credit supported and interest rates anchored at low levels. But at this juncture, with markets hanging by a thread, the US economy showing some signs of weakness and central banks slowly beginning to unwind their monetary policies, we could be in for an interesting ride ahead.

In mid-2017, we had predicted that, bar any major geo political event, a marked slowdown in the US or an abrupt end to QE in Europe, we saw little scope for the rally in global credit to slowdown, and here we are at the beginning of April 2018, and all 3 scenarios have unfolded in one way or another.

Since the turn of the year, we had opined on a number of occasions that we had expected markets to remain supportive and benevolent for credit markets, as they remain buoyed by strong macro, fundamental and technical factors. However, heading into the second quarter of the year, things could get a tad more challenging, as government bond yields continue to rise and the scheduled EU’s Corporate Sector Purchase Programme (CSPP) draws to a close. And if that is not enough to worry about, we have the possibility of a trade war to rack our brains about.

At this juncture, it is extremely cumbersome to gauge or predict how this tête-à-tête between two of the world’s largest economies in the US and China (in the form of a so-called trade war) are expected to impact economies, companies and the markets in general in the months to come. However, in the interim, we do not expect credit metrics to be adversely impacted in an imminent manner. What is expected to be extremely challenging for market participants across all the investment spectrum is the escalation of the whole situation; if it will remain confined and controlled or whether it will impact the greater scheme of things.

With credit still in good shape, we are not particularly concerned in the short term as we do not expect any material carnage to the asset class, but it is seen as something which credit could have done without as recently the ECB has indicated that the central bank appears more intent than ever to stop QE this coming September. It is well known that the CSPP has been instrumental at keeping markets supported, and with the absence of a sizeable and timely bid on the market, we remain aware as well as concerned at the rate of increase in government bond yields in the second half of the year, and the impact it could have on markets per se in the months to come.

Clearly, the March rate setting was a clear sign from the Fed indicating an upward shift in rate trajectory over the short-medium term, as the Committee now expects at least 1 more rate hike till 2020 than it had been previously anticipating. The Committee is however split as to how many rate hikes should be expected this year; 6 members voted in favour of 3 hikes whereas the other 6 wish there to be 4 rate hikes in 2018.

Indeed, interesting months to come, when we have global trade tensions being imposed by the US on a number of large economies. How long will bonds continue to rally and, when yields eventually begin to rise, will the move be sharp enough and not give them enough time to exit the market due to the vanishing of bids on the market? This is what is concerning the bond investors of late, and has resulted in a marked repricing in both the sovereign bond market and lower end of the credit spectrum. These themes have primarily characterised credit markets in the first quarter of 2018.