Credit gains further ground in July

Credit markets clocked in yet a remarkable month in July, and the grind tighter continued. Fixed income proved to be, once again, the most defensive asset class of the lot. In the aftermath of the Brexit vote, and the failed coups d'état in Turkey midway through the month coupled with the Key central bank meetings by the European Central Bank and US Federal Reserve, the incessant global search for yield was still on top of the agenda for investors.

During the month of July, European and US High Yield posted noteworthy gains of 2.02% and 2.34% respectively in a month whereby credit had just come back from a turbulent month, most notably towards the end of June following fears that the infamous Brexit vote could derail markets. This derailment was short-lived and credit began the month strongly, with spreads and yields flirting at 15-month lows.

Turkey was shocked by an attempted military coup on 15 July which failed coup is said to have been orchestrated by Gulenist factions within the Turkish military. This coup was swiftly countered due to lack of support from within the Army’s command chain but more importantly due to decisive public outcry. The situation in Turkey remains extremely fluid and its candidacy for EU membership appears to be at risk following the diplomatic shenanigans which ensued following the failed coup. Risk sentiment in emerging markets, most notably within the MENA region remains volatile as geopolitical risk appears to be intensifying. This explains why High Yield Emerging Market credit trailed their global counterparts, by posting in a positive performance of 1.57%.

Global credit remained supported for most of the month as the ECB’s €85bn in monthly asset purchases intensified the global search for yield by investors. The ECB seemingly front-loaded on its asset purchases during the month of July in anticipation of the summer lull in trading activity, which could have exacerbated the performance of credit during the month, but nevertheless, the spill over from Investment Grade tightening of spreads to Sub-Investment Grade was evident, across both sides of the Atlantic, and so far does not seem to be abating.

With spreads having rallied significantly of late, no one would be at fault for expecting some bouts of profit taking, however credit remains in good shape. This week, we have the outcome of the bank stress tests to look out for, but the main event which could be a game changer for credit this summer is the Italian bank recapitalisation saga. Credit is entering the summer months in very strong shape, courtesy of the CSPP and the ultra-low negative yield environment. Following the Brexit shock which saw spreads widen in very aggressive fashion, the asset class has regained its composure and spreads have rallied in continuous fashion over the past month.

With the ECB expected to provide the markets with additional stimulus in the form of an additional accommodative stance and the US Federal Reserve nowhere seemingly close of another rate hike, credit could well be positioned to grind tighter. Albeit we must highlight the fact that, following the positive run we’ve had in credit so far this year, asset managers will be looking at preserving their year-to-date performance by beginning to position themselves for the final stretch of 2016, so early on in the year.