Credit markets: Q2 2021 in review | Calamatta Cuschieri

Sacrifices borne by governments, businesses, and the public at large, to mitigate the spread of the coronavirus pandemic, certainly leaving a broad and harsh impact on the economic landscape, have in Q2 come to fruition.

Coronavirus-induced restrictions on movement and a vaccination drive, seemingly well-underway in the developed market world, proved crucial, curbing the spread of the deadly virus. The gradual easing of pandemic-inflicted movement restrictions combined with monetary and sizeable fiscal support allowed economies to rebound from worrying lows. A scenario everyone has longed for.

The pick-up in economic activity has however, been partly overshadowed by a sharp pickup in inflation and a rising concern that this could lead to central banks withdrawing some of their stimulatory policies.

Sovereign yields

Euro area: All in all, European sovereign yields have in Q2 pointed higher amid growing optimism about the region’s recovery and accelerating vaccination programme, extending on the previous quarter’s upward trajectory. Owing to measures imposed and vaccination programmes gaining traction, many European countries saw coronavirus infections fall over the quarter and were thus able to loosen restrictions on social and economic activity contributing to an improved economic scenario.

Yields on Europe’s most sought-after benchmark; the 10-year German Bund, closed Q2 higher at -0.21 per cent compared to -0.29 per cent at the end of Q1.

U.S.: U.S. Treasury yields have over Q2 retraced some of the significant upwards moves witnessed in the beginning of the year, then influenced by; substantial fiscal stimulus, higher inflation expectations, and a coronavirus vaccination programme being well underway and ahead of schedule. All of which brightened the outlook for the U.S. economy.

The reversal witnessed came as investors began to doubt whether economic data, notably the upticks in inflationary figures would continue to advance or else prove transitory. The Federal Reserve (Fed) policy meeting in mid-June, was keenly watched. The tone of the Fed, for months wary of signalling an end to its pandemic-induced, ultra-loose monetary policy regime, was indeed hawkish.

The benchmark U.S. 10-year Treasury yield, closed the quarter 27bps lower than the previous, at 1.47 per cent.

Corporate credit market

In balance, Q2 proved positive for the corporate credit market.

European investment grade names, despite initially heading lower following a rise in sovereigns, generated positive returns in Q2. U.S. investment grade, contrasting Q1, also advanced, generating total positive returns as treasury yields retraced some of the large, higher moves in Q1.

Over the stated period, U.S., EM, and European high yield names also generated total positive returns. U.S. and European high yield names returned 2.77 and 1.48 per cent, respectively.

Sector analysis – High yield market

A brighter economic outlook have in Q2 drove sectors closely tied to a resumption to normality and economic growth, higher. Sectors such as services, transportation, and energy have in Q2 performed well.

Services: While the manufacturing sector showed remarkable resilience during a period characterised by coronavirus-induced movement restrictions, services – reliant on mobility and thus direct contact, suffered. The vaccination rollout in many developed countries, being well underway, allowed for the unlocking of economies and a gradual return to normality. Sentiment improved as restrictive measures were eased.

U.S., European, and EM high yield names within the services sector witnessed spread tightening in Q2. EM issuers outperformed with credit spread tightening of 123bps.

Transportation: In 2021, the level of demand combined with the disruptions relating to the pandemic, such as staff shortages, created a severe congestion in global supply chains. In container shipping, this translated into slower asset rotations and severe vessel and container shortages. The Suez incident towards the end of Q1 and Yantian’s recent port closure consequent to a coronavirus outbreak, worsened an already tensed situation. Expectations for liners 2021 financial results are highly anticipated, with optimism.

In Q2, U.S. high yield names within the transportation sector recorded credit spread tightening of 64bps. 

Energy: The single most important commodity in the world begun 2021, nearly how it ended – on a positive trajectory. In June, Crude Oil reached the highest levels in over a year, surging over 50 per cent on a year-to-date basis and offsetting the pronounced losses that transpired in the previous year.

U.S., European, and EM high yield names within the energy sector witnessed spread tightening in Q2. U.S. high yield issuers outperformed with credit spread tightening of 89bps.

Outlook

We believe that a continued rise in immunisation, thanks to coronavirus vaccination programmes being well under way, particularly in the developed market world, shall continue to bode well. Generally, a geographical diversion remains. Economic data, previously showing signs of weakness as the recovery remained constrained by the health crisis, shall further improve, as the resumption to normality continues to pick up speed. However, downside risks, specifically related to the health crisis remain. The recent increase in coronavirus infections, brought about by the ‘Delta variant’, first originated in India and considered to be significantly more transmissible, poses a risk on activity. Countries witnessing a rise in infection rate, have already re-introduced restrictive measures. 

Undoubtedly, focus remains on the degree of inflationary pressures and subsequent move from central bankers, now seemingly increasing their monitoring on the incoming data. We maintain our view that recent price pressures were fuelled by transitory anomalies.

We remain constructive within the high yield space, and more specifically on sectors that should continue to benefit as we approach normality. We are also of the belief that given the economic dispersions, European high yield will be more resilient to its peers, given any amplified curve moves.
 

Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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