Fixed income markets ended the year on a generally positive note. Sentiment remained supported primarily by positive trends in the global economy, accommodative central bank policies, still low inflation, and persistently robust risk appetite levels. However, markets are now moving into what could likely be considered as the late stage of the credit cycle.
Euro benchmark yields climbed during 2017 and the benchmark curve has steepened. The European Central Bank (“ECB”) entered into what could be considered as a “tapering” mode as Quantitative Easing (“QE”) monthly purchases were reduced and extended from €80 billion to €60 billion from April 2017 until December 2017. The ECB announced a further extension and reduction in October 2017 to €30 billion from January 2018 until September 2018. Excluding events such as a sudden surge in political risk or return of deflationary pressures, we would expect yields to end 2018 at higher levels.
In the US, the Federal Reserve (“Fed”) raised interest rates three times during 2017 which currently stand at 1.25%-1.50%. The Fed also began trimming its balance sheet which had expanded to around US$4.5 trillion via the QE programs. Generally, the perception throughout the year was that investors were consistently more “dovish” than the Fed, as also illustrated by a flattening US Treasury (“UST”) yield curve, which was one of the major themes across global markets in recent months.
Credit markets held up well, even though the performance was slightly weaker in the latter period of the year due to the steepening US yield curve and Euro benchmark yields climbing slightly. Valuations have mostly got richer and at this point of the cycle and at current pricing levels, it is difficult to be confident on substantial returns going forward.
The global High Yield market (“HY”) and Emerging Markets (“EM”) sectors continued to perform well. However, the rate of outperformance of HY vs Investment Grade (“IG”) did slow down as the attractiveness of the HY market has diminished compared to recent months and more so compared to recent years. The EM sector had another good year, albeit with a few instances in which there was an uptick in caution.
Markets should expect to receive less of a boost from central bank actions with respect to the withdrawal of QE. Investors should moderate expectations in terms of capital upside and credit spreads are already at or near all-time lows. Rising benchmark yields are likely to have a negative impact on total returns particularly in the sovereign and IG sectors.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.