Viva l'Italia! - Fixed income markets this week


Azhar Hussain, Head of Global High Yield

19 April 2018

Royal London Asset Management’s fixed income team share three key trends they’ve seen shaping bond markets over the past couple of weeks:
1.      La Dolce Vita
The Italian economy might have been forecast as the worst performing economy in Europe, according to the International Monetary Fund’s (IMF’s) World Economic Outlook on Tuesday, however investors in Italian bonds were politely surprised by the price action this week. Italian government bonds have rallied a little in recent days, with 10 year yields heading close to their lowest level in a year. Some market participants have attributed this to the lack of a new government, making it harder to enact reforms that investors might consider unsavoury, while the move also reflects a wider ‘risk-on’ trend across a range of fixed income assets.
Elsewhere, an Italian stalwart is returning to the  high yield market as Piaggio looks to refinance some of its existing debt in favour of a new bond maturing in 2025, buoyed by recent strength in this area. Piaggio is one of the more interesting names in the high yield space, its business tends to be a little less cyclical than some auto manufacturers, thanks to the lower pricing point of its core products and the enduring brand appeal of its scooters. In other words, who doesn’t love a Vespa! 
2.     Risk returns to credit
The aforementioned ‘risk-on’ mood has taken hold across a range of corporate bond markets. In investment grade credit, this has led to strong outperformance from corporate hybrids and AT-1 financial bonds, at a time when the wider corporate bond index has fallen during April, led lower by its heavy weighting to supranational names. We’ve also seen some weakness this week in specific names who’ve been exposed to break-up fears, including WPP and Whitbread.
For high yield investors, after a couple of soggy months markets are flying once again, lifted higher by CCC and single B rated bonds at the expense of BB companies. Spurred on by this positive mood, a range of household names have been touting new deals and refinancing existing issuance, with Piaggio joined by Lycra, Samsonite and Flora margarine.
3.     Demand drought for linkers
In government bond markets, weaker than expected inflation data sent gilt yields sharply lower on Wednesday, before trading steadily higher throughout the rest of the day and pushing higher still on Thursday. Index linked bonds have seen some weakness which looks like it’s currently being driven by supply and demand factors. With less demand from traditional buyers such as pension funds, and with new long dated index linked bonds hitting the market next week, these forces are playing as much of a role as any concerns over the future direction of inflation in the UK.
 
High yield markets have been performing strongly so far this month and the pipeline of new deals looks fairly healthy. With credit spreads in these areas still relatively low, and when the quality of the covenants attached to some of these new bonds is fairly questionable, we believe being picky about which deals are likely to pay off over the longer term is a good strategy. 
For a clear example of how a once healthy sector can deteriorate, high yield investors need look no further than the pessimistic outlook for the UK retail sector, which is also being dogged by a number of issues impacting specific bonds. With store closures, creditor arrangements and profit warnings dotting the headlines, many firms are discovering that a slackening of consumer demand and the prospect of rising interest rates are an uncomfortable combination for thinly stretched balance sheets. In our view, the wider European retail sector offers a much more appealing prospect for bond investors seeking exposure to the high street.

Royal London Asset Management’s fixed income team share three key trends they’ve seen shaping bond markets over the past couple of weeks:

1.      La Dolce Vita

The Italian economy might have been forecast as the worst performing economy in Europe, according to the International Monetary Fund’s (IMF’s) World Economic Outlook on Tuesday, however investors in Italian bonds were politely surprised by the price action this week. Italian government bonds have rallied a little in recent days, with 10 year yields heading close to their lowest level in a year. Some market participants have attributed this to the lack of a new government, making it harder to enact reforms that investors might consider unsavoury, while the move also reflects a wider ‘risk-on’ trend across a range of fixed income assets.

Elsewhere, an Italian stalwart is returning to the  high yield market as Piaggio looks to refinance some of its existing debt in favour of a new bond maturing in 2025, buoyed by recent strength in this area. Piaggio is one of the more interesting names in the high yield space, its business tends to be a little less cyclical than some auto manufacturers, thanks to the lower pricing point of its core products and the enduring brand appeal of its scooters. In other words, who doesn’t love a Vespa! 

2.     Risk returns to credit

The aforementioned ‘risk-on’ mood has taken hold across a range of corporate bond markets. In investment grade credit, this has led to strong outperformance from corporate hybrids and AT-1 financial bonds, at a time when the wider corporate bond index has fallen during April, led lower by its heavy weighting to supranational names. We’ve also seen some weakness this week in specific names who’ve been exposed to break-up fears, including WPP and Whitbread.

For high yield investors, after a couple of soggy months markets are flying once again, lifted higher by CCC and single B rated bonds at the expense of BB companies. Spurred on by this positive mood, a range of household names have been touting new deals and refinancing existing issuance, with Piaggio joined by Lycra, Samsonite and Flora margarine.

3.     Demand drought for linkers

In government bond markets, weaker than expected inflation data sent gilt yields sharply lower on Wednesday, before trading steadily higher throughout the rest of the day and pushing higher still on Thursday. Index linked bonds have seen some weakness which looks like it’s currently being driven by supply and demand factors. With less demand from traditional buyers such as pension funds, and with new long dated index linked bonds hitting the market next week, these forces are playing as much of a role as any concerns over the future direction of inflation in the UK. 

High yield markets have been performing strongly so far this month and the pipeline of new deals looks fairly healthy. With credit spreads in these areas still relatively low, and when the quality of the covenants attached to some of these new bonds is fairly questionable, we believe being picky about which deals are likely to pay off over the longer term is a good strategy. 

For a clear example of how a once healthy sector can deteriorate, high yield investors need look no further than the pessimistic outlook for the UK retail sector, which is also being dogged by a number of issues impacting specific bonds. With store closures, creditor arrangements and profit warnings dotting the headlines, many firms are discovering that a slackening of consumer demand and the prospect of rising interest rates are an uncomfortable combination for thinly stretched balance sheets. In our view, the wider European retail sector offers a much more appealing prospect for bond investors seeking exposure to the high street.

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.