Fixed income monthly investor update – August 2020
16 September 2020 | Topical insights
August saw a continued recovery in risk assets following the sell-off seen at the start of the year. Despite being a traditionally slow month as a result of summer holidays, investors increased their exposure to risk assets by switching out of core investments such as government bonds and into riskier parts of the fixed income market such as emerging markets and high yield1.
Monthly performance by market
|Global government bonds||Corporate bonds||Emerging market bonds|
|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 EMBI Global Diversified (USD Hedged)|
Source: Bloomberg Barclays, 1 August 2020 to 31 August 2020. Bloomberg Barclays Indices are used as proxies for each exposure.
Past performance is not a reliable indicator of future results.
In the government bond markets of developed countries, yields saw a broad rise, especially at the longer end of the maturity spectrum (20 and 30 years). Yields in Germany, the UK and US rose by between 0.16 and 0.28 percentage points1. The US Treasury index posted its first negative monthly return since May and its worst monthly return since January 2018. Treasuries sold off, pushing yields up to their highest levels since mid-June as the Federal Reserve (Fed) unveiled a new inflation policy regime in which it will target an average inflation rate of 2%. The market interpreted this as a tolerance for higher inflation and, as a result, a Fed rates policy that could be on hold for longer. Yields had already risen sharply in June and July as virus cases rose and the pace of reopening local economies slowed across US states.
In corporate bond markets, spreads continued to tighten across the board, led by European and emerging market debt. In Europe, investors seemed to have pinned their hopes of economic rebound on the EU Recovery Fund and ongoing stimulus (via quantitative easing) from the European Central Bank (ECB). Emerging markets (EM) continued to play catch up with the rally in other assets following the slide caused by the Covid-19 pandemic, though spreads remain wide.
European and emerging market debt lead the spread tightening in August
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 31 August 2020.
Following record levels of issuance earlier this year, as companies took advantage of cheap funding costs and increased cash reserves in case of further national lockdowns, August was an unusually quiet month for European issuers. However, issuance in the US surprised to the upside with $143bn of new debt coming to the market early1, taking up some of the scheduled issuance expected for September.
The US new issuance continued to extend in duration as companies took advantage of the low interest-rate environment to lock in longer-term financing. Deals were oversubscribed and new-issue concessions were at a minimum. This has added a good deal of high-quality investment-grade debt to the market as well as duration.
The rally in EM bonds ran out of steam by the middle of the month but the asset class was nevertheless able to generate positive returns as a result of spread tightening. The JPM EMBI Global Diversified TR USD index returned 0.5% for the month, bringing gains for the year to date to 1.37%2.
After a sustained period of outperformance, EM investment-grade sovereign bonds underperformed in August. This was particularly apparent in longer-duration assets as the US Treasury yield curve steepened on concerns that a tolerance for higher US inflation could result in an increase in US interest rates over the longer term. Conversely, EM corporate bonds outperformed due to their typically lower duration and wider spreads, which make it easier to withstand higher US interest rates.
High-quality EM bonds struggled to rally on the back of a rise in US Treasury yields
EM spreads versus US Treasuries
Source: Bloomberg, JP Morgan and Vanguard.1July 2020 to 30 August 2020. The EM spread is the JP Morgan Emerging Market Bond Index Global Diversified spread.
The economic crisis caused by the Covid-19 pandemic continues and will probably endure for some time to come. This slower growth is likely to stress weaker corporate balance sheets, although an unprecedented level of monetary accommodation by governments and central banks should provide some support. We expect to see material dispersion between stronger and weaker companies, particularly those companies operating in sectors affected by social distancing.
The coronavirus crisis is likely to have long-term repercussions for the credit market as developed-country balance sheets are likely to be encumbered by debt, while financial instability and inflation are longer-term risks.
Going into the US elections we feel a more cautious approach is warranted. The early rebound of economic activity appears to be tailing off and the US Treasury yield curve (especially at the long end) shows signs of greater volatility. We are also closely monitoring how the next US fiscal package proceeds and also the rhetoric with regards to trade with China.
The higher-quality investment-grade part of emerging markets has performed strongly since the start of the Covid-19 pandemic and while it is well placed to absorb future economic shocks, in our view the market now appears expensive. Longer-duration issues are also very sensitive to the sell-off in longer-dated US Treasuries as the spread cushion is limited. Further, the tolerance for higher inflation seems to be manifesting itself through a steeper US Treasury curve as central bank policy rates remain anchored and any inflation overshoot would likely be felt over the longer term. As such, we see opportunities remaining in high-yield EM debt, especially where we see improving fundamentals. Some high-yield issuers will struggle with any fresh macro shocks, however, so our approach in this area of the market will be selective.
We have had a constructive view on EM rates since the summer, helped by central bank easing, but feel this may be running its course now. Again we will respond selectively, focusing on countries with good fundamentals and high real interest rates. We also feel that some limited exposure in EM currencies is a good strategy for now, in part due to the weakness of the US dollar.
1 Source: Bloomberg Barclays, 1 August 2020 to 31 August 2020.
2 Source: JP Morgan, data to 31 August 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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