22 JUN

2017

Fixed Income , Topics

Credit markets appear to be expensive

CORPORATE BOND STRATEGY 

Credit markets appear to be expensive

The slowing debt cycle, tighter credit spreads, and decreased central bank support (especially if rate hikes are combined with balance sheet normalization) entice us to take a rather cautious and neutral view on the corporate bond universe. We are particularly prudent towards the US high yield segment which is now witnessing outflows, and appears to be the most expensive asset class among spread products. The asset class could be further hindered by uncertain growth outlook in the US following the struggles of the Trump administration to implement key reforms. Another alternative could be to switch towards products that exhibit higher yields like emerging debt, or bank contingent convertibles (CoCos).
 

Favour European financial credit, CoCos continue to be instrument of choice

We continue to overweight the financial sector vs. the non-financial sector, which benefits from stronger fundamentals and relatively attractive valuations (although spreads are narrowing rapidly and are at low levels). The financial sector is also supported by improving capital reserves (and asset quality), higher margins on the back of rising interest rates, as well as the regulatory landscape. Within the financial sector, CoCos continue to be our instrument of preference. The asset class benefits from earnings recovery, lower duration, and weaker correlation to US Treasuries. In terms of yield, these instruments are matching the levels presented by US high yield credit. Technicals are also sound as there is strong appetite among investors, although we note that supply appears to be reducing. We remain selective as the asset class could witness volatility as a result of specific events, such as an announcement of new regulations, and litigation risks on several banks.