The fear that high inflation, as long as it is accompanied by other factors, will end up causing central banks to reverse their stimulus measures, is what is behind the falls that are being seen in the last few weeks in the government bond market.
But what is happening to the credit markets? The sales that investors in fixed income are undertaking in the heat of a movement known as the reflation trade have also reached them. Indices like the Bloomberg Barclays Global Aggregate Corporate Total Return Index Hedged USD are down about 3% and, according to Morningstar data, corporate debt fund categories are also underperforming so far this year.
The question is whether this correction seen in the credit markets is the end of the rally that the credit market has staged in recent years or, on the contrary, is it due only to a short-term movement. In recent days, two management companies such as Aberdeen Standard Investments and M&G Investments have shared with their investors their expectations for these markets. Both agree that it has a journey and cite different reasons.
High volatility, controlled inflation
The first is that while inflation will continue to occupy investors, they should not be overly concerned. “The big risk is that central banks backtrack on their policies, but the reality is that inflation has been under control for many years. Now people are concerned about a taper tantrum but I don’t think it was something that happened as easily as it did in 2013, ”says Gaurav Chatley, fixed income manager at M&G Investments. And it is that fear that will keep volatility high in the market.
Another reason is that, unlike what happened in past crises, in this one there is no fear of a high rate of defaults by companies due to the unprecedented support measures that both central banks and governments themselves have approved. “Default rates in the US are rising unlike in Europe, where European companies are receiving support from central banks and governments to a greater extent than in the US We should not expect a rise in loan rates. default, “says David Fancourt of M & G’s fixed income team.
The fundamentals accompany
In addition, and the third reason can be considered, according to Craig McDonald, global head of fixed income at Aberdeen Standard Investments, either due to the stimulus measures or the incipient economic recovery, the truth is that business results are being positive. “Better business results are being seen and that implies less leverage which will cause an increase in rising stars and a lower rate of defaults. Credit fundamentals will improve in 2021, ”he says.
In fact, from this manager they have two clear areas where they see the greatest opportunities. “We believe the market valuations are fair but we continue to see options on subordinated debt and BB issues where we see a greater understanding of spreads,” said Felix Freund, European Credit Officer at Aberdeen Standard Investments.
The vision they defend from M&G is very similar, in addition to highlighting the importance of active bond picking management in a context of high volatility and strong dispersion between sectors and between companies. “We must focus on companies that are worth taking the risk of that leverage because they have less narrowing of spreads. You have to be very focused on stock selection ”, concludes Chatley. More taking into account that the potential presented by credit for spreads is increasingly narrow since current levels are very similar to those seen before COVID-19.
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