Thanks to the largesse of central banks, corporate bond markets have weathered the depth of the Covid crisis well. The risks weighing on the credit markets now seem low with a gradual improvement in fundamentals, a neutral central bank policy and no major imbalance between supply and demand.
Listen to the podcast with Victoria Whitehead, portfolio manager on the Global Credit team, or read the article below.
Are investors worried about the impact of rising interest rates and inflation expectations?
Inflation itself is not so much of a problem for corporate bond markets, nor are higher rates. Historically, these markets have reacted more to the volatility associated with rate hikes than to the rate hikes themselves, causing credit spreads to widen (see Chart 1). If you look at the correlations – of what moves credit markets and spreads – the main driver is economic growth. Rate hikes for a positive reason – more growth – are positive for credit markets and we tend to see spreads tighten.
As a result, as the macroeconomic situation improves following the end of lockdowns, improving economies and corporate earnings showing upward momentum, we have seen credit markets significantly outperform others. fixed income segments such as government bond markets this year. We have recently experienced low volatility in credit spreads.
We have two central bank meetings this month that might surprise: the ECB and the US Federal Reserve. However, on June 10, the ECB did not report any changes in its bond purchases. While the Fed may be “thinking aloud” this week about reducing its asset purchases, we consider the risks to credit markets to be low. As a result, large credit movements are unlikely: market positioning is shorter than during previous declines and corporate liquidity reserves are higher.
How have corporate bond issuers handled the Covid crisis?
They handled what was initially a very hectic time relatively well. We were in uncharted territory. Bond spreads widened considerably last March, but it didn’t take long for central banks to step in. The Fed has started buying high yield and high yield “cross” bonds to signal corporate support for the market. Central banks in Europe and the UK quickly stepped up their quantitative easing programs.
In addition, companies have issued huge amounts of debt to consolidate their balance sheets and liquidity, in part because they worried about the impact of the crisis on their credit ratings. As a result, we have not observed any major increase in rating downgrades. The rating downgrades were on companies that were on the verge of falling into the high yield category anyway and the pandemic has just pushed the rating measure forward.
Today we are seeing issuers – the so-called rising stars – returning to investment grade thanks to the economic recovery. Corporate liquidity remains at high levels, with both liquidity ratios and coverage ratios close to historic highs and significantly stronger than previous points of reduction in QE. This not only keeps the company’s flaws remote, but means supply pressures are low.
Are ESG considerations also becoming more important in the credit market?
We have seen tremendous growth in the green bond market. To date, 180 billion dollars have been issued worldwide, equivalent to the annual total in 2020 and also in 2019. Green bonds, issued specifically to finance green projects, now represent 20% of emissions. .
Encouragingly, they are coming on the radar of central banks and their asset purchase programs. The interest in this still relatively small segment in general and the huge influxes mean that green bonds are valued at a slight premium over existing corporate bonds. This attracts more emitters.
Alongside green bonds, there is growing interest in bonds linked to sustainable development, the coupon of which is linked to specific indicators. The annual bond payment increases when the issuer fails to meet sustainability goals, creating an incentive for the issuer to meet environmental, social and governance (ESG) goals.
All opinions expressed herein 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 have different opinions and make different investment decisions for different clients. This document does not constitute investment advice.
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