Credit Markets characterised by mind-boggling Brexit

Stating that credit markets were tumultuous over the first five months of the year would be an understatement. 2016 welcomed by a crude awakening of 6-7 weeks of pure selloff and widening, with the next 3 months or so of market recovery and spread tightening. Heading into June, markets were grappling with conflicting economic data signals across all corners of the globe, coupled with uncertainty about the timing of the next US Federal Reserve’s next move. More importantly, an incessantly yo-yo-ing of predictions regarding the outcome of the infamous Brexit referendum vote dictated market sentiment and direction for most of the month.

Following a sharp downward revision in housing data in the US, it became increasing apparent that the Fed’s Chariwoman Yellen would stay put in June as far as rate hikes are concerned. Furthermore, doubts around the Brexit vote and volatility in the markets in the run up to the referendum took off the sparkle from the positives which came out (and are expected to be reaped in the coming weeks), from the ECB’s corporate sector purchase programme (CSPP), as UK-exposed credit and peripheral spreads came under pressures. The CSPP began on 8 June and credit spreads ground tighter, with many market analysts expecting the ECB to anticipate and front-load its asset purchases in view of the imminent summer lull in trading activity.

Uncertainty over the results of the UK referendum kept the markets on their toes and risk aversion spread quickly only to reverse in the days before the referendum. And then, on 24 June, markets woke up to mayhem, panic last see in September 2008 (Lehman), as the British electorate voted out of the European Union. Clearly, this was not the result the market was gearing for, and was neither evidently not the most market-friendly outcomes, as all risky assets sold off heavily, with some percentage changes even reaching double digits on the day. The Benchmark 10-Year Benchmark Bund reaching intraday historic lows of -0.175%, with high yield spreads across the globe sharply wider. Worth mentioning though that given the large swings, emerging market credit came out relatively unscathed from all happenings in the developed world.

This sharp widening in spreads, particularly in high yield credit made valuations more attractive and created pockets of value, as institutional investors sought to take advantage of beaten down prices, helping spreads recover heading into the month’s close. We would tend to agree that there could be value but it would be too premature to estimate the extent of damage and ramifications of the 23 June referendum result, particularly on a global scale. The economic damage could be at its infancy and this will only start to show up in statistical economic data in a couple of quarter’s time.

The biggest dilemma for investors would be how to tackle this transitory period, as we could well be faced with a business as usual scenario till things really begin to start taking shape. In the short term, we are of the opinion that credit could grind marginally tighter at best, or trade sideways; the lower-for-longer interest rate environment should be supportive for that persistent search for yield that would render it highly improbable for investors to shun the asset class at this juncture. In addition, whilst we are aware that volatility might persist, we believe the ECB’s ammunition could prove sufficient to keep spreads supported from this point forth.