(March 24, 2014) — Credit markets could be hit by a liquidity blip in the second half of 2014, dampening expectations for debt assets, according to Deutsche Bank’s Jim Reid.
After a strong first quarter for credit strategies, the well-known economist said he still expected the first half of the year to be broadly positive for the sector.
But he now feels initial estimates for H2 were too dovish, given the Fed is now talking more confidently about possible rate rises in H1 2015, and the European Central Bank is “not finding it easy to follow through from their pre-emptive rate cut in November 2013”.
“A big factor as to whether we eventually predict wider spreads in H2 is likely to be based on what we see happening to central bank policy as we go into and through H2,” Reid said.
“At the moment our base case is now that there is a market wobble in H2 (due to lower liquidity than we thought) but that central banks eventually respond in a more dovish manner again. Before this we think Q2 will likely be decent for risk as US data snaps back after the weather distortions, thus building confidence in the recovery regardless of whether it lasts through H2.”
Despite this “wobble”, Reid asserted that the technical and fundamentals for credit remained firm enough that credit should remain a low beta asset class to any macro volatility “for the foreseeable future”.
But there was a caveat: if tension around central bank activity leads to a lack of liquidity (or a perception of liquidity tightening) it could cause investors problems.
The full report, which can be found here, also highlighted the range of total returns for the various parts of the credit universe.
None of the sectors analysed by Deutsche Bank provided a return of less than 1.8% or greater than 3.7%, but when looking at the year to date spread changes, a number of the lower beta parts of the credit spectrum saw spread widening.
Higher beta credit generally outperformed, with subordinated financials—in both investment grade and high yield—seeing the best of the performance.
One of the key factors in the performance of credit from a total return perspective has been caused by moves in government bond yields, Deutsche Bank said. It pointed to 10-year bund and gilt yields, which have fallen by more than 25 basis points (bps) in the year to date.
And 10-year bund yields are now only around 50bps above their 2013 lows, indicating that investors are still operating in an extremely low yield environment despite the yield increases seen in 2013, Deutsche Bank said.
Related Content: Why We’ve Not Seen the Back of QE (and Why We’re Not in Recovery Mode) and Is Now the Time to Trust Eurozone Banks?