US and European High Yield indices survived a general fixed income sell-off week, triggered by prospects of higher interest rates on both sides of the Atlantic. This resilience reflected the asset class’ increasing maturity and quality as well as a recently rising correlation...
to equity markets. The week, however, was dominated by the general sovereign bond sell-off that followed the first strong US inflation reading in five months, and which raised market expectations of an interest rate hike in December. Such expectations were further enhanced after the Federal Reserve (Fed) left interest rates unchanged on Wednesday but reassured its forecast to lift them once more this year and another three times in 2018. The US Treasury 10-year yield climped 2.5 basis points to 2.27% after the announcement. Click here to read what Legg Mason portfolio managers said about the Fed's latest move on Wednesday.
In the UK, some traditionally-dovish Bank of England members said that a rate hike may be needed within months. The US dollar soared and US inflation expectations reached a four-month high. The British pound rallied to the highest since the country voted to leave the European Union in June last year. German bund yields also moved upwards as the country’s leading ZEW investor expectations index rose to 17, well above an estimate of 12. In the latest sign of positive momentum in Europe, the region’s car sales growth accelerated to 5.5% in August.
High Yield, one of the most equity-like sectors within fixed income, bucked the trend and posted gains over the past five trading days on the back of the faster expected growth and the present relatively low default rate. European High Yield outpaced its US counterpart, partly because the region is still supported by the European Central Bank’s bond-buying programme. Emerging Markets (EM) suffered from a stronger greenback, although some select EM currencies gained, underpinned by country-specific fundamentals: the Russian ruble, for instance, rose against the US currency as the central bank cut its key rate to 8.50%, a move widely anticipated but that is expected to ignite growth. Oil surpassed the US$50 dollar per barrel mark, reaching its highest level since May, a move that also helped support energy-heavy US High Yield indices.
ON THE RISE
HY – better with age: High Yield indices extended their year-to-date gains over the past five trading days, to 6.6% in the US and to 5.4% in Europe. Apart from the better global growth prospects, the asset class is also underpinned by improving long-term fundamentals. In terms of quality, for instance, the highest rating within the non-Investment Grade universe (Ba) now accounts for almost 43% of the world-leading US High Yield index, up from 38% five years ago. At the same time, the representation of the lowest-rated (or C) companies has decreased, as seen on the chart, leading to an overall improved quality. Also supporting the asset class is the present low default ratio, of an annualised 1.1% in August, the lowest since March 2014, according to JP Morgan data. No wonder High Yield is increasingly showing an equity-like behaviour: its correlation with the S&P 500 Index has risen to 0.43, up from 0.35 in May.
(The bars show the representation of the credit rating within the index in % terms)
Source: Bloomberg Barclays 21 September 2017. Ba, B, Caa and CaD are non-Investment Grade credit ratings, ranked by quality, with Ba being at the top of the quality non-Investment Grade scale. Please see disclaimers for definitions.
Portugal – back in the club: Following years of belt-tightening and International Monetary Fund and European Union programmes, the country’s efforts have finally borne fruit: credit agency Standard & Poor’s raised on Friday Portugal's sovereign rating to the coveted Investment Grade status, leading to a compression in sovereign yields. The 10-year yield plunged to 2.3% following the upgrade, down from 2.8% just three days before. Investors have now moved their focus to the European countries still rated non-Investment Grade by Standard & Poor’s: Greece, Cyprus, Turkey and Russia.
ON THE SLIDE
Gilts – new speed limit: UK sovereign bonds dropped almost 1% over the past five trading days, dragged down by expectations of higher interest rates soon. Earlier this week, Bank of England governor Mark Carney told an audience in Washington DC that Britain’s decision to leave the European Union has cut the country’s economic potential – as if the speed limit of economic growth had been reduced. This makes the country more vulnerable to an overheating, thus the need to hike rates soon. Other Bank of England members also had similar hawkish comments – something which pushed the pound 2.5% higher against the US dollar. Ten-year sovereign yields spiked to 1.33%, up from 0.96% earlier this month.
Central bank’s overheating alert sends UK currency, yields higher
Source: Bloomberg as of 20 September 2017. USD is US Dollar, yr is year; RHS is Right Hand Side. Past performance is no guarantee of future results. Please find definitions in the disclaimer.
Yen – exporting goods, importing currency weakness: The Japanese currency plunged 3.3% against the US dollar over the past five trading days, the worst performance among world leading currencies. The move was partially driven by the same risk-on mode that lifted major world equity indices, and which reduced demand for traditional safe-havens such as the yen. Japan’s own data also confirmed the better global trade mood: the country’s exports rallied 18% in August from one year earlier, a sign that there’s increased appetite for the goods it manufactures. The stock market also reflected the better corporate prospects with a 2.7% jump over the past five trading days.
Source for all data: Bloomberg and Barclays Capital as of 20 Sept. 2017, unless indicated.