Fixed Income

With September set to be the first negative month for most risk asset markets since March, it is worth analysing what has been driving the reversal.

Overall CLO and loan performance have exceeded our expectations, though there are still plenty of headwinds for the market, chief among which is the prospect of further lockdowns and more economic disruption as Europe battles a second wave of COVID-19 cases.

Overall, in our view there may be some temporary volatility ahead which investors can try to sidestep or even take advantage of, but it’s probably not worth trying to be too cute as our medium term outlook is still constructive.

A cut by the Fed or the BoE from here would mean negative rates, while the ECB already has its deposit rate deeply negative at -0.5%.

The Bank’s ability to dampen market volatility has certainly been a comfort to fixed income investors; over the last month £ IG spreads have moved in a range of just 4bp and ended tighter than they started, which compares rather favourably to the 5% peak-to-trough swing in GBP-USD over the same period.

There are still plenty of potential bumps in the road (Brexit, the US election, COVID-19 developments and so on) but the positive technical created by dwindling supply has the potential to push spreads tighter in coming months.

We expect September to be relatively busy with new ABS deals, but there’s a very strong technical developing in favour of ABS and CLOs, which should help performance in the coming months.

There are a number of countries in Europe where the banking sector remains very fragmented, and while a lot of work has been done in Spain with the mergers of multiple ‘cajas’ in the last few years, there is still scope for further consolidation.

If floating vs. fixed is no longer the most pressing question, then investors should be more focused on where they get the best credit spread.

The tweak that we will read so much about with respect to the inflation goal is that the new policy can be viewed as a “flexible form of inflation targeting”, meaning that following periods when inflation has been running below 2pc, appropriate monetary policy will likely aim to achieve inflation moderately above 2pc for some time.

Given most countries are going through the same issues and their fiscal expansions are justified, the relative value has not changed that much.

Yesterday we showed that for European investors, what we speculated on back in March has come true; that the bond market did recover its losses far more quickly than equities, as shown below.