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The month of August continued where it had left off in July – investor sentiment was upbeat after the US and EU agreed to avoid an all-out trade war and work to lower tariffs, in talks that US President Donald Trump hailed as "very strong understanding". Risky assets, with High Yield and Emerging Markets, were once again in demand, as credit spreads tightened. Bonds rallied in the early trading sessions of the month as the demand for yield continued to prevail. However, investors were timid in their trading activity, uneasy as to whether to jump on the bandwagon and ride the good sentiment following improved valuations, or whether it was a relief rally. Financials were amongst the best performing sectors.
Both European and US High Yield markets had a strong start to the month. Uneasiness in the bond rally eventually began to gradually creep in and caused an abrupt halt in credit tightening. Investors took risk off the table heading into the mid-August break despite the fact that we had probably gone through the largest streak of trading sessions without hearing (or reading for that matter) the phrase ‘trade wars’ or ‘trade tariffs’.
Credit markets, particularly Emerging Market assets and Emerging Market currencies were faced with a crude awakening in the second week of the month as a political impasse between Turkey and the US between leaders Erdogan and Trump spiralled out of control, for what can be termed as extremely trivial reasons, with none of them seemingly willing to budge either way. The Turkish Lira plummeted, as did Turkish assets. This stand-off lasted for most of the month and pretty much characterised not only sentiment in EM but also in credit markets and risky assets as a whole.
Weakness emanating from Italy also added weakness to credit, particularly European High Yield and the financial sector, to what has been so far this year an already frail market. Trade wars and the concerns they brought to the market, coupled with EM weakness as well as persistent fears of a looming US recession have prevented yields from the uptick the markets were anticipating. However, risk appetite seems to be creeping upward, albeit timidly, as flows out of EM have abated, and this, could prove to be positive for the trajectory of performance in the months ahead. In all fairness, despite concerns surrounding the sanity of the US economy, US markets (the full spectrum – equities, bonds and credit) have enjoyed a 3 month period of steady inflows. This is likely to have come at the cost of net outflows in Europe and EM as the strengthening dollar coupled with fiscal stimulus in the form of a tax cut, resulting in a boost to US growth and earnings, has proven to be the winning formula for US assets.
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