Credit remains stable as primary market activity drops

The performance witnessed in credit markets over the past week have been relatively muted, with spreads trading within a range and total returns stable, primarily generated through the carry trade. A better showing than the hammering credit got during the previous week where spreads widened significantly, particularly the stronger credits.

All in all, spread levels are relatively flat since the beginning of the year, and with the exuberance in credit witnessed during January nowhere to be seen any more, the market’s attention will swiftly focus on this week’s Italian elections. No great shakes are expected for the markets, both on the upside and the downside and credit spreads are expected to remain range trading.

From a fundamental perspective, the Eurozone economy is in pretty good shape, and is still on its recovery trajectory. There have been upwards revisions, both in economic data and inflationary numbers, and the sanity and state of the economy is intact. Upgrades are outshining credit rating downgrades whilst earnings have, on average, been satisfactory, though nothing to write home about.

The rising benchmark yields coupled with the trimming of the QE program have the potential to derail markets, but that pretty much depends on how abruptly rates rise and how the ECB opts to manage and communicate its intentions with the market. But I do not envisage any imminent threat to credit, as rising sovereign bond yields and central banks’ tightening policies are in my opinion construed by the market as longer-term issues that remain ongoing.

With volatility in both Investment Grade and High Yield markets a couple of weeks ago, it came as no surprise that issuance levels dinked as bond issuers are always reluctant to raise new debt at times of heightened uncertainty and volatility, which lack of bond issuance is perhaps the reason which has prevented spreads from widening. As what happened in the aftermath of the 2008/2009 crisis, where primary markets were completely shut, it is the reigniting of the primary market and an increase in new issue volumes which is need to instil confidence into markets.

It’s a bit of a chicken and egg situation; without confidence, the primary market will not kick off, and with a dearth of investment opportunities in new bond issues and fresh supply, credit investors will be reluctant to put money to work. The presences of strong issuance volumes is clear indicator of a healthy market that is eager and willing to take on credit risk. Heading into Q2, the level of activity in primary markets will give us a clearer picture of that state of credit markets, beyond what is published in headlines economic data prints.

This week, our attention will focus on the Italian elections and the SPD vote in Germany. I do not think or expect credit to react adversely, in either direction, but nevertheless will prompt investors to postpone any investment decisions they might have, and ensure ‘normality’ is restored post elections before investing.

At this juncture, it is imperative for investors to focus on those issues which directly impact credit-related issues. Economies are seemingly in good shape, and more importantly, credit metrics have improved significantly over the past 3 years. But at current valuations and with interest rates still historically low, are investors still being compensated for the underlying credit risk?