It was a much more positive quarter for credit markets, with sentiment improving as US inflation showed signs of moderating and China began to loosen COVID-related restrictions.
The last quarter of the year got off to a slow start, with the themes of high inflation, tight monetary policy and geopolitical uncertainty continuing. Early in the period, US Treasury yields rose sharply, peaking at 4.2% on the 10-year note. However, much of the rest of the quarter brought with it welcome relief for credit investors on several fronts. US CPI inflation fell by more than expected for two months in a row, allowing the Federal Reserve (Fed) to reduce the pace of interest rate hikes. Furthermore, China began to move away from its zero-COVID policy and provided much-needed support for its real estate sector. All of this helped to improve sentiment and to bring US Treasury yields down from their recent highs.
While the investment grade (IG) market initially worsened, both spreads and risk-free rates improved dramatically from mid-October as inflationary pressures moderated, but the Q4 rally only partially offset a very weak year for IG markets. High-yield credit also had a stronger quarter; HY spreads in both the US and Europe rallied significantly, with Europe outperforming as fears of dire energy security risks were allayed. Returns were even stronger through mid-December, however gains were given up as investors digested hawkish central bank outlooks amid thin market liquidity at the tail end of the quarter.
As the year concluded, the prospect of recession overtook inflation to become the primary source of concern among investors. This resulted in higher dispersion (across rating segments and sectors) in loan markets. Elsewhere, CLO and other securitised product spreads recovered, having widened amid the market disruption following the UK mini-budget at the end of Q3. In EM corporate credit markets, the last quarter of the year was the only one in which the market finished higher than where it started; most gains came from late November, with the most significant catalyst being the change in sentiment in China regarding the country’s zero-COVID policy.
