Looking back over the quarter it is difficult not to be impressed by some of the bond market returns. High yield and emerging market debt have clocked 5% over the quarter to leave year to date returns approaching 15%, investment grade credit is approaching 10% over the year and even Treasuries have returned 2.5% ytd, not bad on the back of a 9.8% return in 2011.
Clearly, it is realistic to expect some consolidation over the coming weeks and perhaps a catalyst could be weaker than expected Q3 corporate earnings. Against a backdrop where corporate balance sheets remain healthy this could well present a buying opportunity. Although credit spreads have already contracted by 1% this year to around 1.75% at the index level, look east and remember the message from Japan where credit spreads are just 40bp over government bonds.
The final quarter could also be one where central banks, particularly in the East, continue to surprise. The Reserve Bank of Australia was pretty blunt in the statement accompanying the recent 25bp cut. The global outlook is softer, risks are to the downside, Europe is contracting and growth is slowing in China. Growth elsewhere in Asia continues to disappoint and central banks in the region retain the capacity to ease monetary policy.
This, and other emerging market easing, could well be the next instalment of the global central bank put option. This keeps downside risks low but is also unlikely to create the conditions for a big sell off in core bond markets, particularly as central banks, through quantitative easing, continue to take down virtually all net supply. With cash on the sidelines, portfolios continue to pick up well researched credits.