Looking Ahead to 2017 – Corporate Bonds Best Before…

The “best before” date is supposed to give consumers certainty: How long is the minimum shelf life of a product before it needs to be consumed or used in order to avoid its quality or consistency changing, its expected impact dwindling or before it has potentially damaging effects? Users rely on the product’s properties (be it the taste or therapeutic benefits) not deteriorating until after the “best before” date specified by the manufacturer.

The words of pundits monitoring monetary policy traditionally also include aspects of the “best before” approach; in the old days this specifically related to interest-rate decisions. With the expanded range of instruments central banks have been able to deploy for some years now, the financial markets in particular now focus on the “best before” dates for monetary stimuli in the form of bond purchases. Within the duration of these purchasing programmes, so the expectation, the monetary excess dosage alleviates all the undesired side-effects (meaning price movements) which could encumber the financial markets through economic and political risks. However, one privilege central banks enjoy is that they do not have to set the “best before” date of all their monetary policy measures in stone but can leave themselves scope and let the market commentators do the interpreting.

To stick with the image: Investors in corporate bonds have of late been able to “consume” corporate bonds without any reservations given the newness of the CSPP product, the corporate sector purchase programme first “manufactured” as it were in 2016. With the ECB’s recent announcement that it was prolonging the overarching purchasing programmes, the key factor in 2016 supporting the spreads on corporate bonds was extended to be “best before” at the end of next year.

In our view, the picture for economic conditions in the coming year is moderately more friendly than in 2016. The momentum of global economic growth looks set to pick up slightly, although in particular political uncertainties again constitute latent risks. At the micro-level we expect that the ongoing overall conditions (in particular the low level of interest, limited prospects for organic growth) will lead to continued M&A zest, whereby given the largely sound financial profiles this should not trigger a general squeeze on spreads. Moreover, the over-arching rating regime should remain predominantly stable in 2017 and thus likewise have essentially a neutral impact on risk premiums. After this year’s record, we forecast another bout of brisk issuing activity in the primary market, with the market very willing to absorb the new paper. The latest insights point to the ECB certainly continuing to be present in the market throughout 2017. We expect that in the coming year the central bank will not significantly throttle back on the high pace it has shown hitherto when purchasing corporate bonds, and we deduce from this that there is the potential for spreads to narrow, especially in the first half. However, in the medium term the capital markets will have to adjust to the slow withdrawal of monetary stimuli. We believe a debate on an approaching “expiry date”, meaning potential tapering, could start in the second half of 2017 and then(starting from a low level) trigger moderately higher risk mark-ups. On balance, we expect that year-end 2017 will see the iBoxx € Corp. Non-Financials index almost unchanged on the current level at about 75 basis points.

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