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- Global market fixed income returns were mixed for the month, led by positive performance by high yield (HY) bonds in Europe and the US, as well as the loan asset class
- In the US fixed income performance was driven by rates, not risk sentiment in January. Interest rates increased (bond prices declined) on the back of higher growth expectations and solid earnings
- In Europe, we also saw a similar trend as lower-rated companies outperformed their higher-rated peers
- Emerging Market (EM) fixed income returns declined this month on the back of market volatility, even as robust inflows to the asset class demonstrated continued strong risk appetite amongst investors
US fixed income performance was driven by rates, not risk sentiment, in January. CCC rated bonds and the loan asset class generated positive performance, outperforming all other fixed income markets and equities as US investment grade (IG) bonds, Treasuries, and equities declined. Interest rates increased (bond prices declined) on the back of higher growth expectations and solid earnings. Despite the emergence of new COVID-19 variants/mutations and a slow vaccination roll-out, investors are looking to the second half of the year when they believe life will be moving back to normal, translating into higher growth and lower unemployment. Although US IG issuance was more muted, US high yield issuance had the second biggest month ever, which is particularly notable for January (Source: J.P. Morgan High Yield Bond and Leveraged Loan Market Monitor, February 1, 2021). A wide variety of companies across almost all sectors came to market with the highest quality companies issuing yields between 3-4% and higher risk, COVID-19 impacted sectors issuing in the 8 to 12% yield range (Source: Muzinich estimate). Energy companies comprised several of the higher yielding new issues. Importantly, proceeds were overwhelmingly used to refinance existing debt. There were no defaults in January, the second time in three months this has happened; we expect the LTM default rate to decline materially in Q2 2021 when last year’s defaults roll off.
January saw high yield (HY) credit outperform investment grade (IG) credit in Europe, in both excess and total return, moderated by a rising yield trend in the medium and long-term part of the yield curve. Within the HY space, we saw lower-rated companies outperform their higher-rated peers. In our view, significant inflation expectations and repricing, combined with a stronger economic outlook (amid vaccination progress), drove the rise in yields and outperformance by lower-rated credit. We believe that with inflation rising above the market’s expectation in January, investors are likely to continue searching for yield away from more interest rate sensitive assets. While the IG market was the most popular credit asset class in 2020, we think it is likely that the improvement in the economic cycle will help to channel accumulated cash into higher yielding assets, especially as the default rate risk diminishes progressively from market pricing. While the European Central Bank (ECB) has seemingly shifted its posture regarding the bond market purchase program, the Pandemic Emergency Purchase Programme (PEPP) remains a flexible and powerful intervention tool which we believe should prevent Euro bond market volatility shocks and reassure-long term investors in their search for yield.
Emerging Market (EM) fixed income returns declined this month on the back of market volatility, even as robust inflows to the asset class demonstrated continued strong risk appetite amongst investors. While commodities underperformed this month, central bank commitments to an accommodative and loose policy should continue to bolster EM in the future. We note that in 2020, global central banks increased their balance sheets by $10.5tn (13% of global GDP) and for 2021, global central banks’ quantitative easing buying programs are predicted to continue at a monthly run rate of $300bn (Source: J.P. Morgan Global Data Watch, January 29, 2021). This month, positive vaccine related news (both concerning newly available vaccines and vaccination rollouts globally), continued to be constructive for corporate balance sheet deleveraging and rising global growth. We believe that industrial production and global trade, the “growth engines” for EM, are firmly in expansionary territory. Asian credit, which represents approximately 40% of the EM universe, has benefitted from that region’s comparative success at managing the spread of COVID-19. Furthermore, China has now reported a full market recovery to pre-pandemic levels and consensus for a 2021 GDP estimate is converging on 9%, well above medium-term potential. We believe capital is always attracted to compelling growth stories; yet another reason why inflows into EM continue, regardless of short-term market volatility.