Market summary
- Despite the significant volatility at the start of August following weak US labour market data and a surprisingly hawkish Bank of Japan, the global macroeconomic backdrop was supportive for credit markets over most of the third quarter.
- In the US, falling inflation and expectations of rate cuts led to a sharp drop in Treasury yields. The Federal Reserve subsequently reduced interest rates for the first time in four years in September; after much debate across markets around its potential size, the 50bps cut reflected a slowing labour market and increased confidence around inflation.
- Sovereign bond yields also fell in Europe; the European Central Bank made its second 25bps rate cut of the year in September, prompted by growing confidence around inflation and by economic growth remaining lacklustre.
- Against this backdrop of rallying sovereign bond markets, credit markets across the asset-class spectrum posted gains. The top performers were asset classes that pay fixed coupons; these benefited from the fall in risk-free rates.
- Floating-rate assets such as leveraged loans and collateralised loan obligations (CLOs) lagged fixed-coupon bonds, as they did not benefit from the rally in bond yields. However, credit spreads tightened meaningfully in the loan market – boosted by improved sentiment over the macroeconomic outlook – and attractive carry also helped both markets to deliver strong absolute returns.
Where to focus and what to avoid
- Higher carry (higher income) holdings such as structured credit, loans, and selective parts of the short-duration high-yield and bank capital markets, offer an attractive income profile and favourable downside characteristics.
- In traditional markets, such as US high-yield debt and US investment grade, credit spreads remain near the tightest (most expensive) levels seen over previous cycles; we see limited potential here for further price appreciation or attractive income.
- From a sector standpoint, we see selective value in the banking sector in both senior and subordinated instruments, although this is less pronounced than at the start of the year.
For the full breakdown of Q3 and to see our latest scorecards for the credit universe, read the PDF below.
