Political uncertainty will be the main risk driver for investors to watch out for in the remainder of 2017, according to the European Securities and Markets Authority (ESMA).
In its latest Trends, Risks and Vulnerabilities report, the watchdog reviews market threats at large in the second half of 2016 and uses them to signpost factors to beware of in the coming months.
During the study period, the report explains, the US election created particularly sensitive market conditions: high reactiveness was reflected in increased market expectations of near-term, equity volatility.
“Investment fund liquidity remained a concern,” it notes, “with bond funds registering outflows after the US election.
“The low yield environment and related sustained concerns with regard to excessive risk-taking persisted.”
At the end of the year, says the report, there was “a deterioration in the liquidity conditions for EU sovereign bond markets, with 40-day bid-ask yield spreads rising 1.5bps to 3.5bps. Tighter sovereign bond liquidity may have contributed to the sharp drop in repo rates on 31 December.”
Crucially, it points out: “In an environment of high-valuation risks, uncertainties around the growth outlook for the EU and the global economy – together with the confluence of political events, including the expected commencement of negotiations on the exit of the UK from the EU, [and] several elections in EU member states – are important risk drivers for 2017.”
As such, ESMA’s overall risk assessment remains unchanged from mid-to-late 2016: market and credit risks remain very high – the highest level – while liquidity and contagion risk remain high.
Despite that reading, though, the organisation’s outlook for market, liquidity, credit and contagion risks is stable. And its assessment of how corporate bonds performed last year is glowing.
“Favourable corporate bond market conditions and accommodative monetary policy bolstered an increase in corporate bond issuance in 2016,” it says. “This amounted to €979bn, including €403bn in 2016, up 11% from 2015.
“Activity was particularly strong for investment-grade non-financial corporate bonds (+48% in 2016), which are eligible for central bank purchases. In contrast, covered bond issuance experienced a 20% decline.”
US companies, the report added, “have also been issuing record amounts of euro-denominated debt over the past two years, taking advantage of ultra-low borrowing costs: US issuance of euro-denominated investment-grade corporate bonds (excluding banks) has averaged €24bn per quarter since early 2015 – the highest on record and around 70% more than in 2013 and 2014.”