Good Morning,

Core government bond yields declined last week, placing more pressure (to gain access to the market and build exposures as early as January in light of the expected QE programme to be announced by the ECB shortly) on those investors, such as insurance companies, whose goal is to lock in yields for a long period of time. With 10yr Bund yields at 50bp, and the yield on iBoxx’s Euro sovereign and Euro investment grade credit indices at 1.2% and 1.32% respectively, European insurers seem to be struggling to find a decent yield. The next best alternative will be to focus on a particular segment within an asset class, dissect it well and find the sweet spot, that segment which will generate the more attractive returns on a risk-reward basis. We feel this sector for 2015 is going to be European corporate BBBs.

In terms of performance for US credit, 2014 can be argued to have been one of the weakest for a year not in recession as US HY widened by more than 100bps throughout the year. There have only been two so called non-recession years which fared worse; 1998 as a result of the Russian debt crisis and more recently 2011 following the escalation of the European sovereign debt crisis. The main characteristic behind last year’s decline was clearly the drop in the price of oil and the re-pricing of risk in the energy sector. This theme could well persist in the first half of 2015, however, as the price of oil is expected to find support within the $40-$50 range (Goldman Sachs have incidentally issued a report over the weekend forecasting the price of oil to bottom at $40 a barrel), and analysts year-end expectations point towards an uptick in the price of oil, the energy sector could be well in demand in the latter part of 2015 and recover the ground it has lost over recent months.

Having said that, we are aware that the Energy sector poses a few additional challenges to investor risk appetite, especially US shale gas producers, as the sector is one of the most dense and it is cumbersome to know where companies are positioned on the cost curve, meaning that it will take time for investors to distinguish the strong capital structures from the weak ones.

The main event of the year so far is undoubtedly going to be the forthcoming ECB meeting scheduled for 22 January. Negative Euro area headline inflation will likely prompt sovereign QE at this meeting, whereby we do not exclude the inclusion of corporate bonds in this programme. For the first time in over 5 years, headline inflation in the single currency region turned negative, mainly lending itself to a sharp decline in energy prices. Although core inflation has remained stable, we find it hard to believe that no concrete action will be taken during next week’s meeting (asset purchase of at least €500billion and drive the ECB’s balance sheet to March 2012 levels of €3trillion) since inflation expectations continue to be revised lower. Markets will be closely looking into the text, or rather commentary, by ECB’s Draghi on the issue of risk-sharing as asset purchases without risk pooling could result in a weaker impact of the announcement.

All in all this year, we remain somewhat upbeat on credit for 2015, particularly Investment Grade (BBBs remain our top pick, refer to our HY and IG credit outlook which should be published on our website over the coming days, please click on for further details) despite a scenario of current low yields and low expected returns across most asset classes. Credit continues to be in demand at times of moderate growth, low inflation, and accommodative monetary policy, which is why we believe that both IG and HY will be well bid for most of the year, with the IG (investment grade) sector tightening more than its HY (high yield) counterpart.

Have a nice day!