Investors decided fairly early this year that, with the help of a dovish Federal Reserve, the big negative move of Q4 2018 was not signalling the beginning of the end, and was instead a dip to be taken advantage of. The rally since has barely paused for breath, with a sustained and broad-based recovery taking hold.
While many parts of the global fixed income markets had seen spreads widening and yields rising for most of 2018, the US credit held in very well until Q4, when it became the epicentre of global volatility and sold off aggressively. But having begun the year out at 8.05%, by the start of this month the yield available on the US high yield index had rallied to 6.5%. This move rewarded investors with a total return of over 6.4% for the first two months of 2019, matching what many strategists had predicted for the whole year. It has been a similar story for global fixed income markets, with euro high yield having returned 4.2% and sterling high yield 3.6% in the same short period.
Last week saw a noticeable change in mood, as the rally reversed and risk-off assets performed strongly. So why the sudden change?
One of the drivers of the poor sentiment was undoubtedly weaker economic data. Most notably, China reported a fall of 16.6% in exports year-on-year when growth of 6.6% was expected, while the US reported only 20,000 new Non-Farm jobs were created in February, the third lowest reading over the last five years and well short of the 180,000 expected. In the same batch of US data, the unemployment rate ticked lower to 3.8% and average hourly earnings growth increased to 3.4% year-on-year, though these positive readings did little to combat the weak sentiment and Treasuries rallied to their recent low yields as investors searched for safe haven assets.
However, while the weak economic data didn’t help markets, weaker technical factors were also big drivers. Given the strength of the rally enjoyed so far, it wasn’t surprising to see investors book some profits; they pulled almost $2 billion from US high yield funds last week, the biggest move since December. In addition, just as investors were beginning to take stock, the new issue market ratcheted up a notch with firms selling over $8bn of new high yield bonds – the busiest supply week since mid-2018.
All in all, while some of the gains have been given back, the markets absorbed the new issues in a fairly orderly manner and investors still have appetite for attractively priced deals. While yields have rallied a long way, they are still significantly higher than the majority of last year and we expect investors will continue to put money to work, though the “easiest” gains have probably been booked and new issues will have to be attractively priced to attract new money.
The “correction” witnessed last week probably signals a sensible market, rather than anything more sinister.