The BoE’s announcement in August that it would purchase £10bn of investment grade corporate bonds had an immediate, palpable effect on the asset class. Though there was a good deal of debate around the necessity and long-term efficacy of the UK central bank’s asset purchase programme, the rebound in sterling credit was undeniable.
“UK corporate bonds spreads widened by almost 30 basis points after the surprise vote in late June to leave the European Union,” said Pothalingam. Now, sterling investment grade bonds have rallied by around 5% more than the equivalent UK gilts since the Brexit vote and that is in large part due to the BoE’s actions, he pointed out.
The “quick gains may be over,” but thanks to tailwinds from the BoE’s announcement, there is still reason to have a “constructive” outlook on the asset class, especially as “corporate fundamentals remain intact with balance sheets healthy,” asserted Pothalingam.
He also anticipates that the supply of new issuance will be matched by investor demand.
“Prior to the BOE announcement, market consensus was that net issuance in sterling credit would decline by £10-£15 billion in 2016, equivalent to 2%-3% of the BoA/Merrill UK Corporate Index, he said. “However, since then issuance has increased sharply, with UK-related companies taking advantage of low funding costs. As such, the expectation is that net issuance will now be positive in 2016 and 2017. Far from being overwhelming, however, we expect this new supply to be matched by new demand – from both the BOE and retail funds, where year-to-date flows have moved from net negative in June to marginally positive today.”
All this points to a technical tailwind for UK credit, Pothalingam said, albeit one resulting in spreads grinding lower, rather than contracting sharply.
However, as the BoE’s bond purchases dampen spread volatility in sterling credit markets, issuer selection based on strong credit analysis will be key to maximising return potential over the long term, he added.