Curmi & Partners

Delta Variant Dampens Investors’ Confidence

By Simon Gauci Borda

While financial markets continue to keep a close eye on the rise in inflation, economic growth and monetary policy decisions taken by the major central banks, the Delta variant has stolen the limelight in recent weeks as investors fear the implications of a rise in virus cases both in Europe and the U.S.

The Delta variant has once again brought to the fore investor’s fears that a rise in virus cases may lead to an economic slowdown which in turn would dampen the economic recovery through the reintroduction of restrictive lockdown measures required to curb the spread of the virus.

However, while the new virus strain has brought about a resurgence in the number of cases, it is important to note that the current level of hospitalisations and death rates are lower than what was seen in the early stages of the pandemic. In fact, following the development of the vaccine and the subsequent rollout by countries, the achievement of herd immunity has led to the easing of restrictions in recent months with countries such as the U.K. easing all restrictions even as the Delta variant has led to a sharp rise in virus cases.

The euphoria seen within financial markets in the last couple of months quickly dissipated once the number of cases started to increase due to the Delta variant. Investor demand for safe haven assets such as U.S. Treasuries and German Bunds increased, pushing sovereign yields lower when compared to the start of the year.

Naturally, this shift in investor’s preference to safe havens has led to some widening in corporate credit spreads, both within the U.S. and Europe, despite the U.S. economy being at a more advanced stage in its economic recovery compared to Europe. Moreover, Credit Default Swaps, which act as a form of insurance and can be used to infer investor risk sentiment, rose during the past month reflecting concerns over the rise in cases and the effects on the global economic recovery.

Whilst presently the level of risk appears elevated given the rise in cases, credit rating agencies have continued the upgrade trend seen since the start of the year as credit metrics continue to improve rapidly as a result of rebounding economies, vaccine rollouts, abundant liquidity within markets and a strong appetite for risk even at the weakest end of the credit spectrum. This year alone, there have been three times as many ratings upgrades compared to downgrades, however it is important to note that despite this positive momentum, these upgrades remain a fraction of the sheer scale of negative rating actions that occurred at the onset of the pandemic in 2020. Also, notwithstanding some recent spread widening, corporate credit spreads continue to trade at significantly tighter levels compared to 2020, with issuers at all rating levels tapping capital markets to take advantage of lower rates.

The conditions within the corporate bond market continue to be supported by the major central banks, with the European Central Bank pledging to significantly increase the pace of asset purchases while keeping rates steady. Meanwhile the Federal Reserve has pledged to keep its asset purchase programme unchanged at $120 billion in bond purchases per month, though has provided indication that a slow-down in asset purchases may be on the cards given the improvement seen in the U.S. labour market and rising inflation.

Going forward, further spread compression, particularly within the high yield space, is expected within European corporate bond markets during the second half of the year while U.S. corporate bonds are expected to post muted levels of returns given the inflationary fears and talk around the Federal Reserve tapering its asset purchases. However, the impact of the Delta variant and the subsequent rise in cases clearly shows that while markets have rallied considerably from the pandemic lows, investor confidence can quickly dissipate at the slightest indication of unexpected events that may put into question the current pace of the economic recovery.

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.