Viewpoint | December 7, 2021
Corporate Credit Outlook 2022 - Time to Harvest Carry
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of December 2021 and may change without notice.
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Global Macroeconomic Backdrop
We expect economic growth to continue to hold above potential in 2022 in advanced economies and to slow down in developing economies versus 2021. We expect inflationary pressures to decline somewhat in early 2022 but not far or fast enough to relax tensions at the short end of the curve.
We believe the Federal Reserve is likely to start to raise interest rates by mid-2022 at the earliest, while it could take up to the end of 2023 for the European Central Bank to be fully prepared to raise interest rates. Emerging market central banks have already started to rate hikes and most of these policy actions will mature in 2022. We expect real yields to move up in 2022, pushing nominal rates higher as well. The long end of the curve should be well anchored in the process, which may flatten the long end of the curve slightly further while the short end may steepen further.
While we maintain our preference for credit risk over duration risk from a structural standpoint, there is room for a more tactical approach to duration management in flexible portfolios. Our view for barbell strategies, duration wise, reflects our perception of significant uncertainties surrounding Covid-19, inflation’s slow deceleration and the reaction function of central banks. We expect a high volatility environment in government bond markets to persist in 2022.
- Fundamentals - corporate credit fundamentals peaked in 2021 from the low point of Q2 2020 after the start of the pandemic, but remain robust with sound balance sheets within a robust earnings cycle. Defaults remain low and net leverage has improved. Positive credit migration continues to be a tailwind, especially for high yield.
- Technicals – expected to improve in 2022 with lower net supply likely, especially in high yield. The demand for short duration floating rate instruments should also continue. In addition, we expect a continued increase in the issuance for ESG-related bonds in high yield and investment grade.
- Valuations – even after the November 2021 widening, credit spreads remain historically tight. However, the strong credit metrics and the search for yield may keep credit spreads within a range similar to Q4 2021.
- We believe ‘carry will continue to be king’ in 2022. Against expectations of continued global growth, investors are likely to keep overweight in risk assets and buy-on-the-dip, provided severe lockdowns can be avoided. Our preference for carry means keeping the 2021 overweight in high yield through the first part of 2022.
- Current valuations and Covid-19 uncertainties suggest keeping a quality bias when investing in high yield as cash flow generation will be the focus to generate low volatility carry. We see an interesting relative value proposition in European high yield when incorporating foreign exchange hedging costs.
- Securitized credit, leveraged loans and private debt investments should see high demand, all floating rate instruments offering higher carry and lower volatility versus bonds. They are also expected to contribute nicely to enhancing the Sharpe ratio of portfolios.
- From a sector allocation standpoint, we like a combination of commodity producers, selective reopening/cyclical sectors which have some value left, and some defensive sectors with reasonably high cashflow generating power.
- Our portfolios are likely to continue to have exposure to bank subordinated debt. Banks are likely to benefit from a normalisation in rates and steeper curves. Bank balance sheets also appear healthy despite the severity of the recent pandemic-induced recession. We keep a positive opinion on diversified financial senior debt.
- We require better valuations to resume an overweight in corporate subordinated bonds.
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