How has credit fared so far in May?

The sharp tightening trend from mid-February to the end of April has ended. News from China is seemingly deteriorating, US profit figures have been choppy whilst interest rate expectations in the US may start rising rather than remaining in the lower for longer phase. To top it all up, Brexit and the US elections are amongst the key events which could lead to a sharp repricing of risk. All of these factors are damaging the outlook for both equity and credit markets. With the flurry of earnings releases slowing down, we expect the markets to focus more on the impending UK referendum and the CSPP. In terms of credit, issuance on the primary market will be the big focus for investors if volumes remain in abundance.

Euro-denominated credit markets are seemingly witnessing an oversupply at the moment which has led credit spreads wider. If markets remain choppy and volatility intensifies, I think that supply could subside. However, having said that, recent new deals were heavily oversubscribed in the international bond market. Furthermore, I think that heading towards the Brexit vote investors will be more cautious about peripheral credits relative to core Europe.

May has indeed been a cruel month for equity and credit investors alike, with global spreads losing steam over recent two weeks after three months of gradual tightening. Fundamentals have not been kind to global risk appetite, with Chinese figures uncertain, European political risk picking up, and US growth looking rather soft.

European bonds remain supported however against other bonds primarily due to the fact that European rates are not expected to increase any time soon. This is important as it has been one of the key factors which allowed European investment grade credit to de-tach itself from the weaker markets in 2014, which emanated due to the divergence between Eurozone and US rate expectations. Furthermore, the Corporate Sector Purchase Programme (PSPP), which, in simple terms is announcement by the ECB to purchase European corporate bonds on the secondary market. The details of the plan are getting clearer and clearer as on 13 May 2016 the markets got more clarity on which central banks would be responsible for buying which issues. Key to the success of this programme will once again depend on the level of supply on the primary market.

Clearly, the credit market’s recovery rally has become more range-bound trading in nature as spreads have mostly oscillated sideways during the past three weeks. Ongoing concerns regarding the Brexit vote next month, coupled with a chunky issuance calendar ahead, the June Fed meeting (now taking centre stage following the release of the FOMC minutes as well as chatter by Fed’s Dudley last week), the ever presence of the ‘sell in May’ mentality and finally abating global growth/deflation remain reasons for investors to keep their feet on the brakes for adding additional risk on credit.

Meanwhile, there are no major events scheduled for this week, however we have a number of economic releases to contend with, which are expected to give a clearer indication on the shape of the global economy. We believe that the market will be closely digesting comments made by Fed officials Lacker and Dudley last week, who indicated that rates could be hiked in June or July given the improvement in global financial conditions. Last week’s FOMC minutes caught the market by surprise and place the June or July meetings as the expected next rate hike, with futures now imply an over 30% chance for a hike at the June meeting and over a 50% chance of a hike by the July meeting, compared to just 5% and 20% the prior week.