Credit Markets in December 2016

December is characteristically a strong month for credit, and this time was no exception. Coming on the back of what had been a gruelling start to Q4, credit had its fair share of weakness during the months of October and November, December turned out to be a rather positive month for the asset class. Trading activity and news flows are generally muted towards the second half of the month due to the festive period, with some moves exacerbated due to thin trading volumes, so the major focus of investors was the first couple of weeks, and they had quite a handful of events and data points to contend with.

The outcome of the Italian constitutional referendum in the first weekend of the month was very much priced in, despite the potential negative headlines and implications for the Italian banking system and possible spill-over into the European banking sector. Investor’s major focus was clearly the 2 key central bank meetings by the ECB and the US Federal Reserve during the first and second weeks of the month respectively.

During the December rate-setting meeting, ECB’s Draghi confirmed that the program would be extended by an additional 9 months and the rate of monthly purchases reduced by €20bn to €60bn. This continued to exacerbate the shift in risk aversion away from the less risky alternatives to asset classes having higher prospects of returns in the wake of expected improvement in economic data, prompting a pronounced re-pricing in sovereign bond yields.

On the other hand, Fed Chairperson Yellen raised interest rates by 25 basis points, indicating that in 2017 there could be yet another three rate hikes should positive economic conditions persist and warrant such as move. This had an adverse effect on Emerging Market credit and prompted a marked re-pricing in sovereign yields across the Atlantic with the benchmark sovereign yields reaching peaks mid-way through the month, only to retreat thereafter by the end of the month.

Following the volatility witnessed during the early stages of the month, mainly on the back of the 2 central bank meetings and Italian referendum, and aftermath of US elections, yields stabilised and in view of this, credit ended the month in positive territory with European Investment Grade and European High Yield credit registering a total return of 0.53% and 1.74% respectively. Within the same context, US Investment Grade and US High Yield credit registered a total return of 0.67% and 1.82% respectively. Emerging market bonds on the other hand posted a satisfactory 0.80% positive gain, despite the expectations of potential headwinds from a rising interest rate scenario in the US.