Fixed income quarterly investor update – Q3 2020

14 October 2020 | Topical insights

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Commentary by Kunal Mehta, senior investment product specialist

After undergoing a sharp selloff during the first quarter, risk assets experienced a strong rebound in Q2, buoyed by unprecedented levels of support from central banks around the world.

Economic data was generally weak and there remained considerable uncertainty surrounding an economic recovery. Nevertheless, investors appeared optimistic that the current and future commitments from monetary and fiscal authorities would be enough to bridge the gap in economic activity while public health remains the primary concern.

Quarterly performance by market

Global government bonds

Corporate bonds

Emerging markets

 

UK

Europe

US

HY

 

Bloomberg Barclays Global Aggregate Treasuries (USD Hedged)

 

Bloomberg Barclays Global Aggregate GBP Corporate (USD Hedged)

 

Bloomberg Barclays Global Aggregate EUR Corporate (USD Hedged)

 

Bloomberg Barclays Global Aggregate USD Corporate (USD Hedged)

 

Bloomberg Barclays Global High Yield (USD Hedged)

 

JP Morgan Emerging Markets Bond Index Global Diversified (USD Hedged)

 

+0.48%

+1.66%

+2.27%

+1.67%

+3.55%

+2.32%


Source: Bloomberg Barclays, 1 July 2020 to 30 September 2020. Bloomberg Barclays Indices are used as proxies for each exposure.

Past performance is not a reliable indicator of future results.

Government bonds

In the government bond markets of developed countries, UK and US yield curves steepened slightly while the German yield curve flattened somewhat, as the yields on longer-maturity German government bonds dipped1.

While the US Federal Reserve (Fed), the European Central Bank and the Bank of England remained accommodative, by the end of the quarter they had reduced direct support, including making bond purchases in the open market. The Fed also announced it would explicitly allow inflation to run above its 2% target to make up for prior periods when inflation was lower, making the timing of a future interest rate hike more difficult to gauge.

Credit markets

All major segments of the corporate-bond markets generated positive returns over the quarter as interest rates remained range bound and credit spreads continued to compress. Lighter primary market issuance over the summer months, coupled with a steady demand for yield, fuelled the slow but steady tightening in spreads.

Credit fundamentals remained under pressure as countries, corporations and consumers continued to be negatively impacted by the effects of Covid-19 induced population lockdowns and worries about economic recovery.

Credit spread levels

Option adjusted spreads (bps)

Source: All Bloomberg Barclays indices: USD Aggregate A and BBB Corporate Index,  Emerging Market USD Aggregate Index, Global Aggregate Supranational Index, EUR Aggregate A and BBB rated Corporate Index, Asia Pacific Aggregate A and BBB rated Corporate index, US Securitised ABS and CMBS indices and US Corporate High Yield Index. Global Aggregate Credit index. As of 30 September 2020. 

Although the pace of central bank quantitative easing has slowed meaningfully, the commitment to a prolonged period of looser monetary policy remains firmly established and there is ample capacity remaining through additional support facilities if markets were to show any signs of instability. A lack of comparable support from the fiscal policy side remains a key risk for markets as the duration of the pandemic stretches beyond the intended timelines of initial relief packages. 

Emerging markets

Emerging market sovereign bonds generated strong positive returns in the third quarter as the investment-grade segment of the market saw spread levels return to near pre-Covid-19 levels1. High-yield issuers retraced only about half of their selloff, however, due to the segment’s weaker credit fundamentals.

Emerging market bond spreads

Source: Bloomberg, JP Morgan and Vanguard.1 January 2017 to 30 September 2020. The Emerging Market bond spread is the JP Morgan Emerging Market Bond Index Global Diversified spread.

Primary-market issuance was also heavily tilted towards the higher-quality end of the market, with those lower-quality issuers that did choose to participate having to offer large concessions to attract prospective investors.

Outlook

The re-opening of economies across the world has progressed with variable degrees of success and the biggest risk to markets remains a broader second-wave shutdown. This would disrupt already-fragile recoveries and test the capacity and effectiveness of additional monetary and fiscal stimulus.

Beyond the uncertainty surrounding the ongoing Covid-19 pandemic, we see room for market volatility to increase heading into the year-end. The US election, a stalled US fiscal-relief package and complications around Brexit all have the potential to weigh on investor sentiment and move market prices.

We would take advantage of better prices if that were to occur; meanwhile we remain focused on adding value by ensuring we retain appropriate diversification across our best ideas.

Our outlook for corporate-bond markets took on a more cautious tone from mid-summer as valuations recovered back to near their long-term averages. From here, in our view, progressively weaker credit fundamentals suggest that spreads could very well widen. Conversely, the insatiable demand for yield underpins the momentum for further tightening. In this environment, we see value in having appropriate levels of liquidity to add additional risk if valuations were to improve while remaining focused on the best relative-value opportunities across sectors.

In emerging markets, we believe the Covid-19 pandemic will have long-lasting impacts. Government balance sheet deterioration resulting from the necessary public health response and lost economic activity will likely increase debt burdens. However, many countries, emerging market and developed, that had to absorb the largest increases in debt burdens were also those with the strongest balance sheets and the most fiscal room. Debt levels will therefore remain mostly sustainable in our view. On the positive side, the asset class will continue to be supported by a prolonged period of global central-bank accommodation. 

 

1 Source: Bloomberg, as at 30 September 2020.

 

 


Important risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

Some funds invest in securities which are denominated in different currencies. Movements in currency exchange rates can affect the return of investments.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall.

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