Fixed income quarterly investor update – Q2 2020

28 July 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)

 

0.88%

9.21%

5.54%

8.73%

11.84% 

12.26%

Source: Bloomberg Barclays, 1 April 2020 to 30 June 2020.

Past performance is not a reliable indicator of future results.

Government bonds

In the government bond markets of developed countries, the unprecedented volume of quantitative easing caused yield curves to steepen across the board but especially so in the US and UK1. In the UK, the yields on gilts with 2-year to 6-year maturities fell into negative territory for the first time in history.

In the US, short rates remained anchored and yield levels stayed relatively range-bound across the curve. Yields on 10-year US Treasury bonds have remained firmly below 1% as continued uncertainty around economic growth, global demand for safe-haven assets and the US Federal Reserve’s (Fed’s) pace of Treasury buying have all contributed to lower long-term rates.

Credit markets

The corporate bond markets too were helped by the monetary policy response of central banks, in particular the Fed’s buy-back programme, which included high-yield bonds.

Credit spreads recovered close to pre Covid-19 levels1. In the US high-yield and asset-backed securities (ABS) markets, spreads retraced 2.20 and 2.72 percentage points, relative to March-end levels1. US dollar- and euro-denominated investment-grade bonds recovered by 1.22 percentage points and 0.9 percentage points1 in spread terms respectively.  Overall, spreads on the Bloomberg Barclays Global Aggregate Credit Index tightened by 1.01 percentage points over the quarter1.

Spreads tighten across the board in Q2

Source: All Bloomberg Barclays indices: USD A Corp and USD BAA Corp refer to the USD Aggregate A and BBB Corporate Index; EM USD Agg: IG refers to the Emerging Market USD Aggregate Index; Global Agg – Supranational and Global Agg – Credit refer to the Global Aggregate Credit Index; Pan-European Aggregate: Corp A and Pan-European Agg: Corp BAA refer to the EUR Aggregate A and BBB rated Corporate Index; Asian Pac Corp A and Asian Pac Corp BAA refers to the Asia Pacific Aggregate A and BBB rated Corporate Index; ABS and CMBS refer to the US Securitised ABS and CMBS indices; US Corp HY refers to the US Corporate High Yield Index. As at June 30 2020.

Past performance is not a reliable indicator of future results.

In terms of issuance, healthy demand and the opportunity to access cheap funding was seized on by issuers, creating an active pipeline of new bonds coming to the market.

The US and Europe investment-grade bond sector saw considerable new issuance, mostly in longer-dated bonds, notably 20-year maturities. In terms of the rating breakdown, A- and BBB-rated bonds made up the large part of supply. On the whole, the new issuance was well supported.

Emerging markets

Emerging market bonds lagged the early leg of the credit-market rally as investors favoured the safest, most stable segments of credit. However, the sector quickly caught up in May and went on to experience a strong quarter as spreads recovered rapidly, retracing over 60% of the widening from March’s selloff and returning +12.25%.

JP Morgan Emerging Markets Bond Index - Global Diversified spreads recover from March widening

Source: JP Morgan, Bloomberg, Vanguard. 1 January 2019 to 2 July 2020.

Past performance is not a reliable indicator of future results.

Emerging market sovereign issuance totaled $97bn in the second quarter, a quarterly and year-to-date record. While emerging market high-yield issuance grew in May, it continued to lag investment-grade issuance in June. Inflows into hard-currency funds continued their upward trajectory as $4.3bn entered the asset class in June, after $1.3bn and $1.4bn of inflows in April and May respectively2. Conversely, local-currency funds suffered outflows, experiencing their fourth consecutive month of outflows in June.

Outlook

The climb out of a global recession will be a lengthy process and the trajectory and pace of any corporate recovery will likely be led by the success of lockdown-easing measures. This will vary significantly between corporate sectors and issuers, creating an environment best suited to bottom-up security selection. The most important dynamic ahead will be the tug-of-war between the substantial amount of central bank support provided and the harsh realities of economic contraction. 

While central banks may not provide new or additional programmes of support, their commitment to a well-functioning market should provide a brake to any large-scale downturn or excessive spread widening.

Overall, we expect credit spreads to trade in a relatively confined range. However, should volatility increase, we are well prepared to amend our risk profile and capitalise on new opportunities. We believe the ‘easy money’ has been made in the investment-grade segment of the market and generating outperformance will be far more challenging over the less-liquid summer months.

In our view, the corporate-bond market has further room to run given the strong technical indicators of supply and demand. Although investment-grade valuations have recovered a long way already, they still look cheap in a world of financial instability.

Emerging markets should remain resilient over the summer months owing to positive sentiment around lockdown easing and further policy accommodation. However, risks are building up again and the initial stage of the market rally may be behind us. We maintain an overweight to high-quality emerging market bonds and are wary of lower-quality new issues that have taken advantage of recent momentum. While we expect risk to remain within normal ranges in the near term, an increase in risk is possible in August and September as the long-term impact of the Covid-19 crisis comes to light and the market focuses on the US presidential election.

 

1 Source: Bloomberg Barclays, as at 30 June 2020.

2 Source: JP Morgan. Date ranges referenced are 1 April 2020 to 30 April 2020; 1 May 2020 to 29 May 2020; and 1 June 2020 to 30 June 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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