Timing and managing expectations is key

In the Eurozone, short term expectations are for additional QE measures to be announced in the September MPC meeting, with markets pricing in a high likelihood that this will occur, especially given the robustness of European credit, particularly Investment Grade and High Yield corporates in addition to the fact of a now stronger Euro which needs to be depreciated following strong QE measures in the U.K., for competitiveness purposes. As I have opined in previous publications, we continue to favour a short term bias to European HY credit (not on a valuations but on technicals coming out of the ECB) as well as the longer date European Sovereign Yield curve, where peripheral yields are trading well above negative territory.

The summer has been relatively benign for European credit. Uncharacteristically, August has proven to be a month whereby spreads across all sections of the credit curve tightened, and appear to be testing the lows witnessed in 2014. Demand for the asset class remains supportive, the ECB’s bond buying programme remains intact and supply is, so far, nowhere to be seen unless for re-financing purposes.

With September round the corner, we expect the ECB purchases to be back at the fray and the European terms with possibly tighter valuations. It would be interesting to see whether investors would cash in, protect year-to-date performance and switch to other alterative currencies or other higher yielding asset classes. In fact, there are a number of US dollar bonds which trade at a significant yield premium over similarly comparable euro denominated paper.

Elsewhere, we expect US credit markets to come to terms with the happenings over last weekend’s symposium at Jackson Hole where the overall hawkish tone has led to a re-pricing in US denominated assets, particularly the short end of the US Treasury Curve. Markets could well be a tad volatile this week as trading liquidity is expected to be thin in anticipation of the Labour Day holiday on 05 September, with the sentiment in credit markets taking cue from any shift in either expectations or tone by the Fed or any Fed official(s) thereof.

Heading into the Jackson Hole meeting, markets were somewhat jittery but credit remained relatively robust, with both high yield and investment grade bonds better bid. The drop and below-par supply on the primary market has also aided credit markets from a technical perspective, with short-term direction expected to be dictated by the Fed.

In fact, the tone and comments from several Fed officials heading into the symposium gave reason to believe that Yellen would skew towards an inclination of a September rate hike, and this keeping its options open regarding hiking by year-end.

September or December? When should we expect the next rate hike? The situation is quite fluid, and uncertainty remains high. However, it is an almost certainty that at least one rate hike will come before the year’s end, and this was reflected in the re-pricing of Fed Futures rates. Expectations for a September rate hike rose to over 40% from just 20%, in just a week, whilst expectations for a December rate hike rose to well over 60% from slightly above 50% over the same period. Clearly, nothing is certain at this stage, what is for sure is that the Fed will be base its policies on incoming data, and this Friday’s payroll will be one of the key highlights to look out for this week. What is certain is that the market is now commencing to seriously price a hike. This is also being reflected within the dollar currency which gained circa 1.4 per cent over the past days.