BlueBay: Bear(ish) necessities

Risk assets traded stronger over the course of the past week with the US equity market pushing back towards its historic highs, just below 2,100 on the S&P 500 Equity Index. Sentiment was helped by oil prices breaching US$50 per barrel, though away from oil performance of other commodities remains more mixed.

Iron ore prices at US$44 have now retraced two-thirds of the up move between the January lows and the mid-April high, whereas copper remains close to US$2.00 per pound suggesting that global demand continues to be relatively soft.

Elsewhere the US dollar has remained somewhat firm in FX markets, with the greenback up over 3% this month thanks to more hawkish Fed comments. We believe that the Federal Open Market Committee will lean towards raising rates in June or July as long as financial markets remain reasonably stable, though the next sign of intent from the Fed is unlikely before Yellen speaks on 6 June.

Economic data releases are rather sparse at this time of the month, though firm figures with respect to durable goods and home sales continue to point to a comparatively healthy US backdrop.

In Europe, a robust IFO survey from Germany offset a more downbeat assessment in eurozone PMI figures, but the principle topic of debate continues to be the European Central Bank (‘ECB’) and speculation with respect to the upcoming corporate bond purchase programme (‘CSPP’).

We expect to hear more details on the CSPP at the upcoming ECB meeting. Thus far we have heard some differing comments from representatives of different national central banks who will be conducting this programme. In this context, the responsibility for the implementation of the programme will sit with quite junior individuals who are not privy to all of the information themselves, and so hearing what Draghi has to say on this topic will be important.

Greece has also been back in the news with Athens making progress towards passing the first review of the current bailout programme, which would make Greek government bonds eligible for quantitative easing purchases. With Greece seen as the proverbial ‘canary in the coalmine’, a reduction of risk in Greece is seen as broadly supportive for the periphery in general and the high-yielding markets in the periphery in particular.

Sovereign spreads rallied over the course of the week and in Europe, this was also helped by the perception that Brexit risks are receding and that index tracking funds will be forced to extend duration this month as a result of an earlier increase in 30-year and 50-year bond issuance.

Looking ahead, the Fed’s next meeting and the Brexit referendum stand out as the two big events in the month to come. However, in the near term, our focus in the coming week will be more on the ECB. We believe that a lot of good news is already discounted in European corporate bond spreads, notwithstanding that spreads are now wider than they were the day after the original ECB announcement of the CSPP in March.

Anecdotally, it was interesting to read news that Allianz is considering a potential share buy-back, which would be the first time they have ever done this, just weeks after issuing corporate bonds at a zero percent coupon . Coming in the same week that Bayer launched a bid for Monsanto, that could see its ratings fall into BBB territory with adjusted net leverage potentially doubling in our opinion, it is tempting to think that voluntary balance sheet re-leveraging is an increasingly likely side effect of ultra-low corporate bond yields in the eurozone and so investors loading up with paper on an ECB trade may be missing a deterioration in underlying credit fundamentals.

Looking across peer groups, we sense that our bearish stance on credit spreads is very non-consensual right now. This makes us very happy to run this risk on the thinking that with others running long risk exposures, there may be more marginal sellers than buyers and were the ECB to do anything to disappoint this week at a time of heavy supply, then risk reward favours a short stance.

Mark Dowding, partner & co-head of Investment Grade Debt at BlueBay Asset Management

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