Credit Markets: July in review | Calamatta Cuschieri

On the back of a resumption in activity and increased vaccination rates, economic data started to portray a more benevolent economic landscape. Optimism had also improved. However, what many had feared transpired. The resurgence of the deadly coronavirus pandemic, once more, dented sentiment, raising concerns that the path to normality may be bumpier than previously anticipated.

The Delta variant, first originated in India and considered to be significantly more transmissible than previous strains, is said to be behind the recent rapid increase in infections. Countries witnessing a rise in infection rate, led their authorities to re-think their way forward, with some resorting to a re-introduction of restrictive measures. 

Albeit the rise in coronavirus infections called into question the sustainability of economic momentum, economic data has largely remained positive.

Selective data points depict a benevolent scenario

In July, the Eurozone Manufacturing PMI stood at 62.8, slightly higher than a preliminary estimate of 62.6, but down slightly from 63.4 in June and the lowest since March 2021. Meanwhile, services – previously posing a drag on the Euro area’s economic recovery, rose to 59.8, lower than a preliminary estimate of 60.4 but above June’s 58.3. July’s reading marked the steepest pace of expansion in the service sector since June 2006 amid easing of coronavirus-induced measures in many member states.

Eurozone inflation was estimated at 2.2 per cent in July of 2021, higher than June’s actual 1.9 per cent and above economist expectations of 2 per cent. July’s flash reading is the highest since October 2018.

Aggregate business activity in the U.S., as measured by the Composite PMI Index was revised lower to 59.9 in July 2021 from a preliminary estimate of 59.7 and below June’s 63.7. The rate of expansion was the softest since March 2021 amid a slower upturn in service sector activity.

Annual inflation rate in the U.S. remained steady at 5.4 per cent in July, unchanged from the previous month’s 13-year high. In 2021, inflation has largely been on the rise amid low base effects from an unprecedented 2020 and as the economic recovery picks up, restrictions ease, and demand surges amid widespread vaccination programmes and fiscal support. Higher food prices and new vehicles weighed on the Consumer Price Index (CPI).

Albeit economic data points continued to depict a benevolent scenario, credit markets were largely conditioned by concerns over the Covid-19 Delta variant and signs of global growth possibly easing, particularly in China – an economy which was first to recoup from the health crisis and is central to the global economic recovery. Consequent to these concerns, Government bond yields, which move inversely to prices, declined in the month of July.

Sovereign Yields

Euro Area: European sovereign yields have in July pointed lower, intensifying the downward pace envisaged towards the end of Q2. Notwithstanding benevolent economic data and vaccine roll-out acceleration, investors sought safer assets amid concerns about the economic impact of the Delta variant and expectations of continued massive bond buying by the ECB.

Yields on Europe’s most sought-after benchmark; the 10-year German Bund, closed the month significantly lower at -0.46 per cent compared to -0.21 per cent at the end of June.

In July, the ECB announced its first strategy review since 2003, which included a “2 per cent inflation target over the medium term”, compared to the previous “below but close to 2 per cent” and the inclusion of climate change consideration in monetary policy operations. Albeit the goal was changed, the tools at their disposal to achieve such target, thus far, remain the same. The ECB’s Governing Council saw stronger forward guidance added to the statement. The governing council expects interest rates to “remain at their present levels or lower levels until it sees inflation reaching 2 per cent”.

With multiple asset purchase programmes already in place and little room to further cut interest rates, it appears that fiscal policy rather than monetary policy is the most viable tool which may aid the Eurozone to breakout of the low-growth, low-inflation environment.

U.S.: U.S. Treasury yields have over the month of July continued to retrace some of the significant upwards moves witnessed in the beginning of the year. The reversal witnessed initiated as investors began to doubt whether economic data, notably the upticks in inflationary figures would continue to advance or else prove transitory. In July, the downward trend worsened amid a spike in coronavirus cases across the U.S. and globally, consequent to the more transmissible Delta variant.

The Federal Reserve (Fed) policy meeting towards the end of July, was keenly watched. In-line with market expectations, the Fed left the target range for its federal funds rate unchanged at 0-0.25 per cent and bond-buying at the current $120 billion monthly pace. The policy statement issued following a two-day meeting acknowledged the fact that the economy was indeed making “progress”, in-line with the Fed’s mandate, signalling that tapering could start soon, should data further improve, particularly in the labour market. The Fed also acknowledged that there was upside risk to the inflation outlook, but retained the view that this would be transitory.

Corporate Credit Market

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

European and U.S. corporate credit moved relatively in tandem. Investment grade, outperformed, generating total positive returns as European sovereign yields and Treasury yields retraced some of the large, higher moves witnessed in Q1.

Over the stated period, European and U.S. investment grade returned 1.17 and 1.21 per cent, respectively. 

High yield names with the exception of emerging market (EM) high yield, also ended the month on a positive. EM high yield, the laggard for the month of July, lost 1.57 per cent. 

On a year-to-date basis, high yield names, with the exception of EM high yield whose performance turned red following a negative month, outperformed. U.S. high yield issuers – the best performers on a year-to-date basis, returned 4.07 per cent.
 

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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