Let’s face it. 2016 has been more than benign for international bond markets. Ok, the first six weeks of the year were nothing to ride home about, but the rally which ensued beat analysts and investors’ expectations and forecasts. In my previous articles, I have stated that I would not rule out markets turning choppy in the final quarter and profit-taking trades reigning in, with a correction in long-dated European Sovereigns, albeit small in nature, materialising to a certain extent.

Investors had become too complacent in the first 5 months of 2015, as the accompanying sell-off to what had been a remarkable start to 2015 was sharp, and painful to say the least.

Who would say that this time things are different? Fundamentals are still (relatively) supportive now, but they were event stronger 18 months ago, yet the market still corrected. Once bitten, twice shy. Will investors remain as complacent as they were in 2015?

I very much doubt, yet it is still a danger which shouldn’t be taken too lightly as we know too well following the performance we’ve had in 2016, both in terms of total return as well as spread tightening, that heading into 2017, the upside potential within the bond market is stretched and the downside potential is by far greater.

Credit metrics have improved in the European Investment Grade and High Yield market as corporations have successfully extended their debt maturity profiles at significantly lower financing costs. The asset class remains supportive by technicals as demand remains robust and QE remains intact, so far as market chatter on the potential end of the ECB’s QE programme could dent or weaken the technical part of the formula.

The ECB’s MPC meeting is due in 2 days’ time, and anything short of a dovish tone by ECB officials could result in an uptick in volatility. Uncertainty as to whether the ECB QE programme will be extended beyond March 2017 is rife.

We have come across market chatter that QE tapering could be on the cards, which I believe is too premature at this stage, as this would signify that inflation is on the uptick (which is not the case) and that there has been a consistent string of positive economic data releases (must admit here, data has been surprising to the upside), which is in turn is a supportive backdrop for economies and for the appetite for risky assets.

However, this could potentially have the reverse effect as the removal of liquidity, cheap forms of financing and the notion of free money, could result in a fresh bout of risk aversion kicking in.

As I have stated in previous publications, communication by the ECB is going to be key, and this time round is no exception as it could have devastating effects on the way market participants interpret the intricate implications of ECB statements and their tones.

This is exactly why it is imperative to take informed decisions of each and every investment, as to what you invest it and the market timing. Heading into 2017, credit metrics will matter and stock selection will be more important than ever. It is not going to be a free joyride and jumping on the bandwagon in the hope that QE will keep bond prices across all spectrums supported will be dangerous, as it is when the market gets jittery that the good credits stand out from the not so good ones, and not when there is a bid for almost any type of paper around.

This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.  


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