In June, the iBoxx Euro Corporates index tightened by 5 basis points to a level of 63 basis points over the swap curve. This is equivalent to 83 basis points over the government bond curve. The index earned a total return of +0.43%. German 10-year government bond yields closed June at -0.21%, representing an decrease of 2 basis point compared to the end of May.

June was a relatively quiet month for credit markets. Even quarter end did not produce a meaningful pick up in volatility. Summer started early it seems. However, underneath the calm facade a lot happened during the month. Especially the increase in COVID infections due to the spread of the delta variant started to impact parts of the market at the end of the month. Also there are growing concerns about the recovery in the second half, but this has in turn reduced fears of an imminent withdrawal of monetary stimulus. Furthermore, the inflation debate is continuing but so far the market seems to believe the FEDs line that current high inflation rates are transitory and will come down later in the year.

All these sometimes contradictory views on the future kept spread volatility in the credit space relatively limited to approximately 5 bps from the high to the low. Bund yields on the other hand, initially declined by almost 9 bps to -0.27% after increasing again to -0.16% for a high to low volatility of over 10 bps. The rate closed the month at -0.21%, 2 bps lower than at the start of the month.

Economic data throughout the month remained strong in the US and Europe while they are weakening in Emerging Markets. Several developments are causing the slowing visible in Emerging Markets. First of all China is actively tightening financial conditions with the aim to increase economic stability. Also the lock down relaxations implemented in Europe and North America are causing a consumption shift from products to services which is not helping export depended economies.

The ECB left the Eurozone’s headline interest rate unchanged at 0% in June, in line with expectations. Also the PEPP buying pace was kept at a similar pace. Among council members it is clear that the discussion around the PEPP is increasing, with amongst others the president of the Dutch Central Bank repeating that the PEPP will for certain stop in March 2022. Also the ECB is sounding a bit more optimistic that its inflation targets will be reached in the not too distant future. May Eurozone core CPI was revised upwards to 1% from 0.9% earlier. Still some way of from the target but given that May saw only a limited amount of COVID relaxations the reading was encouraging.

US inflation data came in higher than expected increasing by 5% YoY in May (CPI). Also the less volatile CPI ex food and energy came in higher than expected at 3.8%. However this did not have an impact on interest rates as the market for now seems to believe in the transitory nature of the inflation data.

Other economic data from the US showed an economy that is registering healthy growth but also that the peak of the growth increase has passed. Most sentiment indicators are still coming in at healthy levels but lower than in the March – April period.

In the US, yields on 10 year US Treasuries declined almost 13 basis points to 1.47%. This move puzzled many market observers as above mentioned inflation readings were higher than expected. Various explanations were posted. The US Treasury’s decision to run down its FED general account which helped technicals in the government bond market seems to have been a factor that at least explains part of the move. Other than that the market is buying into the FED assertion that the run-up in inflation is transitory and will come down later in the year. This leaves relatively limited room for error in our opinion.

After hopeful figures and developments with regard to COVID infections in May, June initially continued in this trend. The delta variant however started to impact the data more and more later in the month and reality dawned that the virus is not done with us yet despite continued strong progress on the vaccination front.

At the end of June John Hopkins reported the number of global fatalities in excess of 3.9 million. Also around the end of the month, the amount of vaccine doses administered globally broke the 3 billion level, up from 2 billion the month before. In the US however, the vaccination pace slowed. The percentage of the population having received at least one shot increased from 50% of the population to 55% of the population during the month of June. In April and May this percentage climbed by 10 percentage points each in comparison. 47% of the US population is now fully vaccinated. In Europe, several countries are closing in on the US with regard to the level of vaccinations. According to data from Deutsche Bank, Belgium, The Netherlands, Spain, Portugal, Germany, Italy and Finland had a higher percentage of the population with at least one jab than the US at the start of July.

In the last week of June, an infrastructure deal was reached by President Biden and a bipartisan group of Senators. The bill includes approximately 579 billion US$ in new spending, and along with the renewal of existing funding the total spend will amount to 1.2 trillion over the next 8 years. The bill addresses a number of key areas in the Biden “American Jobs Plan”; namely greener public transportation, clean water, universal broadband etc. The current bill has no tax increases, but is instead financed by more stringent tax collection policies from the IRS and other measures increasing the likelihood that it will be passed in both houses of Congress.

In the credit market, the focus was mainly on primary, as the summer lull started early this year. The demand for credit remains strong however. The ECB continues to increase the pace of purchases, with €80.2 billion bought under the PEPP in June, in line with the €80 billion plus average in April and May and 30% higher than the average purchases from January to March. The ECB’s CSPP buying totalled €5.2 billion in June, roughly in line with the average amount bought per month YTD. The ECB now owns over €310 billion in corporate bonds.

Supply of corporate bonds in June amounted to €35.9 billion, with net supply at €17.5 billion. Sector wise Real Estate, Industrials & Chemicals and Utilities are dominating the year to date issuance with in total €37 billion, €30 billion and €43 billion, respectively, issued this year. From a net supply perspective it is again the Real Estate sector that has taken the lead with almost €25 billion YTD. Due to the ongoing strong demand for corporate bonds new issue premiums continue to be small to non-existent this year relative to this time last year when new issue premiums were strong. Many new issues have been priced on top of or even through their existing curves. Corporate hybrids' supply is up significantly to €24 billion year-to-date versus €17 billion last year. Many corporates continue to issue hybrids to support their ratings and to refinance maturing hybrids, profiting from the low rate and spread environment. Financial supply amounted to €22.5 billion in June, which is lower than June 2020 (€27.9 billion). Net supply at €59.4 billion YTD is higher than expected and points to clear front loading of issuance plans by banks so far this year. However due to strong deposit inflow and TLTRO money, issuance is only clearly net positive in subordinated paper and non-preferred senior paper. Senior preferred and covered bonds are experiencing relatively strong negative supply.
Overall corporate net supply totals €76.1 billion YTD and overall financials net supply totals €59.4 billion YTD. Of the corporate net supply, close to half has been absorbed by the ECB.

In June, health care and personal & household goods were the outperforming sectors. Relatively defensive sectors with on average longer duration bonds than the overall market.

During the month, the portfolio’s sensitivity to market trends varied between 101% and 106%. The portfolio therefore held an overweight positioning in terms of market risk. We did manage the beta back to the +3 to +4% area at the end of the month.

Our positioning in telecommunications, food & beverage and oil & gas performed relatively well in June. Our positioning in banks, technology and automobiles & parts had a small negative impact on performance.

At individual company level, positive contributions came from our overweight in Verizon Communications, Total Energies and Coca Cola. Also, our underweight in Vonovia contributed to outperformance, with spreads widening in anticipation of new supply to finance the Deutsche Wohnen acquisition. We also profited from the new issue premium offered on the new bonds. Negative contributions came from our overweight in Fraport and our underweight in Daimler.

In June the Fund participated in new deals from amongst others Nestlé, Vonovia, Gewobag, Bevlux, JD Peets and Repsol. On the banks side, we participated in De Volksbank, SEB, NatWest, Julius Baer and a lower tier two from Bayerische Landesbank. We continue to take a conservative approach towards participating in new issues as new issue premiums are limited and all in valuations are stretched. June is always a heavy new issuance month so despite participating in quite a few new placements, we passed on many others.

Outlook
We remain somewhat constructive on the market. Economic forecasts for the US and Europe have been revised upwards after recent data releases indicate that both regions had shown more resilience than expected. The market is however extremely sensitive to a potential overheating of the US economy, which may lead to a more restrictive monetary policy. Companies’ Q1 2021 results were very strong and so far expectations are high for Q2. We are also seeing initial signs of shareholder friendly behaviour, with quite a few companies increasing dividends or launching substantial share buyback programmes. With further tightening in spreads, valuations are looking expensive. The technical backdrop continues to remain robust with the ECB recently stepping up the pace of bond purchases and net supply remaining at a low level. It is however unlikely that the technical backdrop will improve further and more likely that the next Central Bank move will be to tighten conditions. All in all we have decided to slightly reduce our beta overweight position given these circumstances.