Outlook 2017: Global corporate bonds
In what will likely be another volatile year, we will continue to favour US dollar-denominated credit.
- Volatility will be the rule rather than the exception in 2017
- Corporate credit fundamentals continue to vary by region
- US dollar-denominated corporate bonds more attractive than euro-denominated
As an eventful 2016 comes to a close, we look ahead to what may be an even more eventful 2017. The political shocks seen in the UK and the US may move to the eurozone, where four elections are scheduled to take place in 2017. These events are likely to continue to impact capital markets globally in the coming year.
Global credit markets are likely to be driven by a number of factors.
The president-in-waiting is a decidedly unconventional politician espousing sometimes radical domestic and foreign policies. The US will likely be a source of volatility in the coming year; however, certain macroeconomic policies currently under consideration may also serve as a positive catalyst for the US economy.
The eurozone continues to deal with populist unrest which could trigger dramatic political changes via upcoming elections in the Netherlands, France, Germany and Italy. Tepid economic growth and a banking system that continues to face challenges nearly a decade on from the global credit crisis continue to pose profound challenges for the union.
Hard? Soft? Mushy? Whatever the outcome, the negotiation process is likely to be fraught with challenges for both sides of the bargaining table. Making a case that this is a near-term positive for either the UK or the eurozone is not plausible to us.
Globalisation remains a topic impacting the political discourse. Protectionist policies could be very disruptive to the global economy, and inflationary for many import-oriented economies.
Corporate credit fundamentals continue to vary by region. However, pro-growth economic policies from the new US administration coupled with corporate tax reform may be quite supportive and could extend this credit cycle.1
Quantitative easing from the European Central Bank, Bank of Japan and Bank of England have driven government bond yields to 0% or below. Fixed income investors have been driven to higher yielding markets, such as the US. We are intently focused on these capital flows and believe they should be a significant driver of returns across markets in 2017 as they have been over the past year.
Investment opportunities and risks
We continue to largely avoid euro-denominated fixed income. All-in yields of less than 1% and spreads which are tighter than those in the US or UK are unappealing to us and do not compensate investors for the risks noted earlier.
Instead, we favour US dollar-denominated corporate bonds, primarily investment grade.2 but with some exposure to high yield3 and emerging markets. In the near term, we expect capital to continue to flow into the US credit sectors from Asian and European investors and believe that yields and spreads in this market are more attractive than many other markets.
Within the banking sector we favour the US over the eurozone. We remain positive on the US banking sector as rising government bond yields and the potential for less punitive regulation should benefit bank profitability in the US.
The energy sector was the stellar performer in 2016. We continue to believe that this sector should perform well in 2017, but not nearly to the degree we have experienced in 2016.
The sterling corporate bond market performed very well in 2016 in spite of the uncertainty surrounding Brexit. We think further opportunities could emerge here in 2017.
Although markets enter 2017 with a great deal of uncertainty, we can be fairly certain that 2017 will be eventful and that volatility will be the rule rather than the exception.
As a result, we are maintaining our overall risk level at the lower end of the range from the last several years. Our liquidity position is above average, both to dampen risk and to maintain dry powder to take advantage of any opportunities which may arise.
1. [The term “credit cycle” refers to how easily borrowers can access credit. When credit is readily available, interest rates are generally low, so paying for loans is easier. When interest rates start to rise, credit becomes harder to secure.]↩
2. [Investment grade corporate bonds are the highest quality bonds as assessed by a credit ratings agency. To be deemed investment grade, a bond must have a credit rating of at least BBB (Standard& Poor's) or Baa3 (Moody's).]↩
3. [A high yield bond is a speculative bond with a credit rating below investment grade. Generally, the higher the risk of default by the bond issuer, the greater the interest or coupon.]↩