Back

Credit market monthly review: Oktoberfest ahead of festive season

Credit market monthly review: Oktoberfest ahead of festive season

Insight

PDF 330.2KB

08 November 2017
  • October’s dovish European Central Bank (ECB) meeting boosted euro credit while heavy supply weighed on US dollar credit. On the downside, EUR credit’s spread advantage over USD is vanishing fast, although European macro momentum and ECB quantitative easing (QE) on a €30mn per month ‘autopilot’ until September 2018 do support this.
  • A bull run in spreads for nearly 21 months, combined with low underlying rates, has squashed credit yield break-evens, leaving little margin for error. Our fair value model flags this asymmetry in credit risk, implying a spread widening by 6% in USD investment grade (IG) and 12% in EUR IG over 12 months, for base-case growth and volatility expectations.
  • High yield (HY) should exceed 8% and IG should exceed 5% in total return in 2017. The strong rally in implied volatility makes credit default swap (CDS) index payer strategies quite attractive for locking-in 2017 portfolio performance. 

Tighter, lower, steadier

Credit markets currently resemble the intertwined feel-good narratives of the movie ‘Love Actually’, namely healthy economic growth, strength in corporate earnings, elevated sentiment data, a dovish ECB stance, an upgrade in Italy’s sovereign risk, a cooling off of the situation in Catalonia, manageable supply in primary markets, and investors with cash to invest. As a result, the scene is set for a good run into year-end, compelling investors to stay invested despite stretched valuations and low break-evens, the result of tight spreads and low underlying rates.

Credit enjoyed another strong month in October and August’s jitters have long faded into memory. It was the turn of EUR credit to outperform boosted by a dovish ECB outcome on 26 October, as one third of the tightening in EUR IG came in the last three sessions of the month. Stateside, USD credit went into a ‘holding pattern’ ahead of the release of the tax reform plan and heavy supply also weighed on spreads ($118bn in October in financials and non-financials, a new record for the month of October).

EUR credit advantage over USD yet narrower

The strong performance in EUR credit has helped year-to-date EUR HY returns overtake USD HY, no mean feat considering the carry handicap of EUR HY due to low benchmark rates (-0.4% 5y bund yield vs 2% 5y US treasury) and a high BB content (75% of EUR HY is BB rated vs 48% in USD HY). The downside to this outperformance is that the EUR credit spread advantage over USD credit has narrowed materially in IG, or has outright vanished, in HY. That said, a solid growth backdrop in the euro area and an ECB asset purchase programme on ‘autopilot’ at €30bn per month until September 2018 should continue to underpin euro credit spreads over a 6-12 month horizon.

Credit risk asymmetric by most measures

Stubbornly low underlying rates have combined with the 21 month-long bull run in credit spreads since February 2016 to push yield break-evens ever lower. Indeed, duration-adjusted yields have dropped towards their historical lows in USD credit or broken below their prior historical lows in European credit (well below in the case of EUR credit). At a meagre 12bps, the EUR IG yield break-even leaves little margin for error.

A spread sensitivity analysis based on our macro fair value model for IG credit also highlights the credit risk asymmetry at current spread levels. Out of the four model variables we hold corporate debt to GDP and corporate profits to GDP constant, while we adjust real GDP growth and equity volatility according to our base case scenario. Steady or slightly lower growth and an uptick in equity volatility – due to gradual central bank policy tightening – imply a modest widening in USD IG by 6% and a somewhat more notable widening in EUR IG by 12%.

CDS index hedges can help lock-in performance

HY should exceed 8% and IG should exceed 5% in 2017 total return, assuming no capital gain or loss from now to year-end. Hedging strategies via CDS index payers are worth considering for locking-in performance over the rest of the year, more so following the recent rally in implied volatilities that has lowered their cost further. 

DISCLAIMER

This document is for informational purposes only and does not constitute, on AXA Investment Managers part, an offer to buy or sell, solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date.

All information in this document is established on data made public by official providers of economic and market statistics. AXA Investment Managers disclaims any and all liability relating to a decision based on or for reliance on this document. All exhibits included in this document, unless stated otherwise, are as of the publication date of this document.

Furthermore, due to the subjective nature of these analysis and opinions, these data, projections, forecasts, anticipations, hypothesis and/or opinions are not necessary used or followed by AXA IM’s management teams or its affiliates, who may act based on their own opinions and as independent departments within the Company.

By accepting this information, the recipient of this document agrees that it will use the information only to evaluate its potential interest in the strategies described herein and for no other purpose and will not divulge any such information to any other party. Any reproduction of this information, in whole or in part is, unless otherwise authorised by AXA IM, prohibited.

This document has been edited by : AXA INVESTMENT MANAGERS SA, a company incorporated under the laws of France, having its registered office located at Tour Majunga, La Défense 9, 6 place de la Pyramide, 92800 Puteaux, registered with the Nanterre Trade and Companies Register under number 393 051 826.

In Australia, this document is issued by AXA Investment Managers Asia (Singapore) Ltd (ARBN 115203622), which is exempt from the requirement to hold an Australian Financial Services License and is regulated by the Monetary Authority of Singapore under Singaporean laws, which differ from Australian laws. AXA IM offers financial services in Australia only to residents who are “wholesale clients" within the meaning of Corporations Act 2001 (Cth).

In Belgium, this document is intended exclusively for Professional Clients only, as defined by local laws and the MIFID directive, and is distributed by AXA IM Benelux, 36/3 boulevard du Souverain – 1170 Brussels Belgium, which is authorised and regulated by the FINANCIAL SERVICES AND MARKETS AUTHORITY.

In Germany, This document is intended for Professional Clients as defined in Directive 2004/39/EC (MiFID) and implemented into local law and regulation only.

In Hong Kong, this document is issued by AXA Investment Managers Asia Limited (SFC License No. AAP809), which is authorized and regulated by Securities and Futures Commission. This document is to be used only by persons defined as “professional investor” under Part 1 of Schedule 1 to the Securities and Futures Ordinance (SFO) and other regulations, rules, guidelines or circulars which reference “professional investor” as defined under Part 1 of Schedule 1 to the SFO. This document must not be relied upon by retail investors. Circulation must be restricted accordingly.

In the Netherlands, this document is intended exclusively for Professional Clients only, as defined by local laws and the MIFID directive, and is distributed by AXA IM Benelux- Netherlands Branch, Atrium - Tower A, 14th Floor Strawinskylaan 2701 1077ZZ Amsterdam - the Netherlands, which is authorised and regulated by the FINANCIAL SERVICES AND MARKETS AUTHORITY.

In Singapore, this document is issued by AXA Investment Managers Asia (Singapore) Ltd. (Registration No. 199001714W). This document is for use only by Institutional Investors as defined in Section 4A of the Securities and Futures Act (Cap. 289) and must not be relied upon by retail clients or investors. Circulation must be restricted accordingly.

In Spain and Portugal, this document is distributed by AXA Investment Managers GS Limited, Spanish Branch, has its registered office in Madrid, Paseo de la Castellana no. 93, 6th floor, is registered in the Madrid Mercantile Register, sheet M-301801, and is registered with the CNMV under 19 number as ESI of the European Economic Space, with Branch.

In Switzerland, this document is intended exclusively for Qualified Investors according to Swiss law. Circulation must be restricted accordingly.

This document has been issued by AXA Investment Managers LLC, Qatar Financial Centre, Office 703, 7th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 22415, Doha, Qatar. AXA Investment Managers LLC is authorised by the Qatar Financial Centre Regulatory Authority.

In the United Kingdom, this document is intended for Professional Clients only, as defined by local laws and regulation, and is issued by AXA Investment Managers UK Ltd, which is authorised and regulated by the Financial Conduct Authority.

© AXA Investment Managers 2017. All rights reserved