Trade war fears set the stage for a tense second half
- Spreads continued to widen in June, this time led by US credit, as trade war fears stole the limelight away from Eurozone political instability. Eurozone risk premia remain elevated despite the near term resolution of political issues (Italian brinkmanship, German coalition) because the September Italian budget looms large as a risk event.
- The silver lining to the almost 50% widening of euro spreads year to date is that excess return expectations 12 months forward have turned positive for the first time in a year. The repricing since May has created tactical opportunities in a number of index pair trades: high yield/investment grade decompression, Europe/US recompression, Financials/Non-Financials recompression.
- The underperformance of the euro high yield market in comparison to dollar high yield has narrowed the yield advantage of the latter net of foreign exchange hedge costs while dollar investment grade maintains a 40 basis point ield advantage over euro investment grade.
Spreads widen in June but trade wars are now the culprit
Spreads continued to widen in June, this time led by US credit as trade war fears stole the spotlight away from Eurozone political instability (Exhibit 1). The dovish announcement regarding the tapering of the European Central Bank’s asset purchase program did not feature as a key driver of spreads. This is not surprising given the time asymmetry present in the announcement effect (abrupt upon inception vs protracted ahead of eventual exit). Furthermore, the asset purchase programme has resumed a higher share of credit market purchases, climbing to around 18% of the total in June (compared to a peak of 21% reached in March).
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