Global credit markets have recovered strongly since the peak of the sell-off experienced in March. With credit spreads having tightened considerably since then, how attractive are the global credit markets?

 

2020 has so far proved to be quite a roller coaster of a year for credit markets, and the volatility that has transpired highlights the need for careful bottom-up security selection underpinned by strong fundamental credit research. Unprecedented levels of stimulus measures implemented by governments and central banks helped to restore calm to credit markets as well as their proper functioning. While volatility picked up slightly in financial markets more broadly in September, risk sentiment in credit markets remains significantly better compared to during the height of the crisis, with credit spreads having tightened considerably since then. In this paper, we take a closer look at the prevailing market environment within global investment-grade (IG) corporate bond markets. 

 

Fundamentals

The pandemic has undoubtedly had a serious impact on issuer credit quality, leading to a raft of downgrades and fallen angels¹. Rating agencies were in fact much more proactive this time around compared to past crises, but the pace of rating actions has since slowed down. Shutdowns in economies have also led to a rapid rise in corporate indebtedness across all parts of the credit spectrum, while the drop in economic activity has impacted the earnings needed to service this debt.

 

Ratings migrations

In the US market fallen angels have totalled US$160 billion year-to-date, up from US$32 billion and US$23 billion the prior two years, with most of the downgrades occurring between February and May, well before second quarter earnings were announced and the full impact of Covid-19 could be assessed². The market is pricing about another US$59 billion of fallen angels, however, some market participants believe this may be overdone and that rating agencies have been too pessimistic in their outlook, with some sell-side research for instance having lowered forecasts of fallen angels for this cycle to US$32 billion.³

Since May there have, in fact, been relatively few companies that have fallen to high yield, but this trend could easily reverse should the economic outlook worsen. Another positive is that the share of BBB debt, the lowest rung in the US investment-grade bond market, has declined since January as a result of both fallen angels and new issuance trends. While the decline is modest, it is nonetheless a change in direction for this metric. It should, however, be borne in mind that there are still a fair number of companies that are struggling, especially where rating agencies are concerned, with an estimated US$290 billion of BBB minus rated debt trading with a negative outlook.² Bottom-up investors focused on fundamentals should be able to distinguish those stronger issuers that have taken on more debt from those that are genuinely struggling.

European investment-grade companies have equally suffered a significant number of downgrades and fallen angels, with a year-to-date volume of fallen angels at €47.4 billion, or 2.1% of investment-grade notional.⁴ However, this figure is still considerably lower than what had been estimated. This was in part due to a quicker economic recovery, fiscal support for the private sector, and actions undertaken by corporates including equity raises, asset disposals, cost cutting, dividend cuts and hybrid issuance. There will undoubtedly be more downgrades to come; however, a nascent European economic recovery and ongoing monetary and fiscal support could help to minimise the damage.

 

1. Fallen angels: Bonds downgraded from investment grade to high yield.

2. As at 17 September 2020. Source: JPMorgan

3. As at 3 September 2020. Source: BofA Global Research

4. As at 10 September 2020. Source: JPMorgan

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.