In December, the iBoxx Euro Corporates Index tightened by 13 basis points to a level of 57 basis points over the swap curve. This is equivalent to 98 basis points over the government bond curve. The index earned a total return of -0.11%. German 10-year government bond yields closed December at -0.18%, representing an increase of 17 basis points compared to the end of November.

December was a surprisingly good month for credit markets after the sell-off in November. This was caused by several factors. Primary activity was limited as is normally the case in December. Demand for credit paper however remained strong and this provided a positive technical backdrop for spreads to tighten. Furthermore, although Omicron did cause corona infection rates to spike, several studies showed that the variant seems to be far less deadly than earlier variants. This helped risk sentiment as well. Lastly, another explanation given was that the expected speedier tightening by the FED would prevent inflation getting out of hand which would allow overall rates to stay low in the intermediate timeframe. We see this as an overly optimistic scenario.

Inflation data stayed at high levels in Europe and the US during the month. They even increased further from already elevated levels. In November US CPI climbed to 6.8% YoY from 6.2% a month earlier, the fastest pace in 40 years. Core CPI also increased further, from 4.6% to 4.9% YoY. In Europe, CPI increased to 4.9% from 4.1% while core CPI also increased further to 2.6% YoY from 2% the month before. Also more and more companies announced substantial price increases to keep their margins in check. Ikea for example raised prices on average by 9% to offset the impact of higher input costs. Furthermore, the US labor market remains very tight further stoking inflationary forces. Average hourly earnings increased by almost 5% YoY in November. Note that this still doesn’t cover the overall CPI increase.

Economic activity remained at a high and expanding level in the US and Europe although they were slightly lower than the month before. The US ISM manufacturing index came in at 58.7 vs 61.1 in November. In Europe, the Euro Area Composite PMI was largely flat at 53.3. At the end of the month, economic activity seemed to be negatively affected by the consequences of the high omicron infection rate. This caused employee shortages in various industries as many workers had to go into quarantine or self-isolate. Also demand weakened somewhat as consumers decided to limit their activities to reduce the chance of being infected.

Government bond yields increased in December after tightening in November. This largely happened during the last 10 days of the month and continued during the first week of January. Bund yields widened by 17 bps, OATs by 18 bps and BTPs by 20 bps. Over the whole of 2021, bund yields widened by 39 bps, OATs by 53 bps and BTPs by 63 bps.

In credit, primary markets activity was limited in December. At €4.9 billion gross, activity was almost half last year’s €9.6 billion. The split between financials and corporates was €1 billion / €3.9 billion. Net supply amounted to minus €21.7 billion. The turmoil on the credit markets in November had a spill-over effect on issuance plans in early December. Many corporates decided to wait for more stable markets which materialized in the second half of December. However, at that point activity in the credit markets already levelled off substantially in anticipation of the holiday period. As a result issuance plans were postponed till January.

Euro investment grade saw issuance of €487 billion gross / €210 billion net in 2021 broken down into €268 billion gross / €139 billion net from Financials and €219 billion gross / €71 billion net from Non-Financials. Financials issuance set new records, supported by continued MREL senior issuance, above-expectation preferred senior and bank LT2 volumes, and extremely heavy REITs supply. By contrast, this was the lowest Non-Financial volume in eight years in both gross and net terms. Also covered bond issuance activity was significantly lower than in the preceding years.

The demand for credit remained solid in December with approximately €2 billion inflow in EUR IG, based on JP Morgan data. CSPP purchases in December were however clearly lower than in the preceding months (€2.6 billion vs €5- 5.5 billion average in the months before). The PEPP purchases were €49 billion in December. This was also clearly lower than in November (€68 billion) and significantly lower than the approximately €80 billion on average in the May – July period. In December, the ECB announced its intention to completely stop with the PEPP after the March 2022 end of the program. No new program was announced although the ECB kept the flexibility to initiate new asset buying programs. This was a bit more hawkish outcome than expected by the market.

In December, Financial Services, Infrastructure and Industrial Goods & Services were the underperforming sectors. Automobiles & Parts and Insurance were the best performing sectors.

The portfolio delivered a return of -0.14% (gross). This was 3 basis points below the benchmark return of -0.11%. During the month, the portfolio’s sensitivity to market trends varied between 101% and 104%. The portfolio therefore held an overweight positioning in terms of market risk in combination with a relatively high cash balance, government bonds and Supranationals. With spreads contracting substantially this defensive positioning had a slight negative impact on our relative returns. It explained all of the relative underperformance. The contribution to the relative return by sector was small but in general positive. Also the relative return contribution by issuer was small both on the positive side as on the negative side.

In December, the Fund participated in new deals from Orange and Aroundtown amongst others. On the financials side, we participated in Westpac NZ. We continue to take a conservative approach towards participating in new issues as new issue premiums are limited and all in valuations are stretched.

Outlook
Despite increasing uncertainty caused by higher inflation, rising COVID-19 infection rates and the rapid transmission of the Omicron variant, we remain mildly constructive on the market. US and European economic data remains strong but growth rates are slowing. Companies’ 2021 results are in general strong. However we are currently seeing more aggressive shareholder friendly behaviour, with more companies increasing dividends, launching substantial share buyback programmes or engaging in M&A. With spreads still near all time lows, valuations are considered expensive. The technical backdrop continues to remain supportive for now with the ECB continuing to actively buy corporate bonds and emphasising that actual tapering of assets purchased will be done in a gradual manner. However, as we have seen in the US, this outlook can change quite quickly.