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A merry Christmas rounds out a good year for credit

A merry Christmas rounds out a good year for credit

Credit market monthly

Key points: 

  • Spreads were broadly tighter in December but the uptick in interest rates prevented High Yield (HY) credit markets from reaching the 8% watermark in 2017, or 6% in the case of Investment Grade (IG). Still, against initial expectations, 2017 turned out to be a good year for credit.
  • HY/IG spread decompression has been a notable dynamic since the late October spread lows, particularly in European HY where it is consistent with the reduction in quantitative easing (QE) in the Eurozone. Indeed, the credit share in December dropped to 6% of asset purchases but we expect this to rebound to 15%-20% of the monthly total of €30bn.
  • Any reversal of flows into lower-rated credit as QE declines should be gradual and November’s idiosyncratic correction does not foretell a turn in the credit cycle and a wholesale repricing in HY. Furthermore, fears about interest deductibility loss post tax reform are rather misplaced and price action in 2018 seems to corroborate this view. Amid rising yields, we maintain our preference for HY over IG as potential spread widening in the former is unlikely to exceed spread breakevens.

December caps a strong 2017 in credit

A Santa Claus rally pushed credit spreads tighter in December (Exhibit 1) after November’s correction proved to be yet another short-lived episode. The fall in primary supply was also supportive by bringing investors back into the secondary market. USD credit spreads outperformed during the month in the wake of the US administration’s tax reform legislation – the Tax Cuts and Jobs Act (TCJA) – in addition to the lack of supply. A rise in yields however took away from excess returns and held back the global HY market from reaching the 8% total return watermark in 2017 (Exhibit 2) or 6% in the case of global IG. Still, against consensus expectations at the start of the year, 2017 turned out to be a good year for credit. 

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