Thanks to central bank largesse, corporate bond markets weathered the depth of the Covid crisis well. Risks to credit markets today appear low with gradually improving fundamentals, neutral central bank policy and no major supply-demand imbalances.
Listen to the podcast with Victoria Whitehead, portfolio manager on the global credit team, or read the article below.
Inflation itself is not so much a problem for corporate bond markets nor are higher rates. Historically, these market have reacted more to the volatility associated with rate rises rather than the actual rate rises themselves, causing credit spreads to widen (see exhibit 1). Looking at correlations – of what moves credit markets and spreads – the main factor is economic growth. Rate rises for a positive reason – more growth – are positive for credit markets and we tend to see spreads narrowing.
Accordingly, as the macroeconomic situation improves on the back of lockdowns being wound down, economies improving and company earnings showing rising momentum, we have seen credit markets outperform other fixed income segments such as government bond markets substantially this year. We have had low credit spread volatility recently.
We have two central bank meetings this month that could conceivably surprise: the ECB and the US Federal Reserve. However, on 10 June, the ECB signalled no change to its bond purchases. While it is possible that this week the Fed may ‘think aloud’ about tapering its asset purchases, we view the risks to credit markets as low. As a result, big moves in credit are unlikely: market positioning is shorter than at the time of previous tapers, and corporate cash buffers are higher.
They managed what initially was a very turbulent period relatively well. We were in uncharted territory. Bond spreads widened significantly last March, but it did not take long before central banks stepped in. The Fed started buying high-quality high-yield ‘crossover’ bonds to signal its support for corporates to the market. In Europe and the UK, central banks quickly stepped up their quantitative easing programmes.
In addition, companies issued enormous amounts of debt to shore up their balance sheets and liquidity, in part as they worried about the impact of the crisis on their credit ratings. As a result, we have seen no major rise in rating downgrades. What downgrades there were involved companies that were on the cusp of falling into the high-yield category anyway and the pandemic just brought forward the rating action.
Now, we are seeing issuers – the so-called rising stars – coming back into the investment-grade category on the back of the economic recovery. Corporate cash holdings remain at high levels with both liquidity ratios and coverage ratios close to all-time highs and notably stronger than at previous QE tapering points. This renders corporate defaults not only remote, but means supply pressures are low.
We have seen huge growth in the green bond market. To date, USD 180 billion worth has been issued globally – that is the equivalent of the full-year total in 2020 and also in 2019. Green bonds, which are being issued specifically to fund green projects, now make up 20% of the issuance.
Encouragingly, they are coming onto the radar of central banks and their asset purchase programmes. Interest in this still relatively small segment in general and the huge inflows mean that green bonds are being priced at a slight premium to existing corporate bonds. That is attracting more issuers.
Next to green bonds, there is growing interest in sustainability-linked bonds whose coupon is connected to specific indicators. The bond’s annual pay-out rises when the issuer fails to deliver on sustainability targets, creating an incentive for the issuer to meet environmental, social and governance (ESG) goals.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
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