Fixed income monthly investor update – December 2020
21 January 2021 | Topical insights
Risk assets ended the year on a positive note as Covid-19 vaccine developments turned increasingly constructive and the virus-related risk premium on fixed income assets diminished. Further support for risk assets came from the validation of US presidential election results, which confirmed a victory for Joe Biden. A last-minute agreement on a Brexit deal was an additional relief.
On the policy front, investors continued to navigate the opposing influences of deteriorating economic fundamentals and growth versus increased central bank liquidity and supportive technical factors.
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, 30 November 2020 to 31 December 2020. Bloomberg Barclays Indices are used as proxies for each exposure.
Past performance is not a reliable indicator of future results.
The pick-up in investor optimism was reflected most strongly in the US Treasury yield curve, which steepened as the yield on 10-30-year bonds rose approximately 20bps. In contrast, the German government bond curve experienced some flattening, as the price of short-maturity bonds fell more than longer-maturity bonds. In the UK, government bonds saw little change1.
Credit spreads tightened across all sections of the market in the final months of 2020. December, as is typical, was a quiet month in terms of news regarding corporate fundamentals and essentially the market continued to be driven by an extension of the themes seen in October and November; namely, a continued slowdown in negative ratings action and third-quarter earnings surprising on the upside.
With ratings agencies having already taken action on the issuers that are being most adversely impacted by Covid-19 restrictions, investors are now awaiting details on the likely speed and path to normalcy and the consequential effect this will have on ratings. On the earnings front, third-quarter earnings, while weak, did surprise to the upside and expectations are for the fourth quarter of 2020 to remain similar before there is a rebound in the first quarter of 2021.
Technical factors generally remained supportive in December; primary issuance remained low, liquidity from investors stayed strong and demand from investment funds continued to be healthy.
Credit spread levels
Source: All Bloomberg Barclays indices: Global Aggregate Credit index, Emerging Market USD Aggregate Index, USD Aggregate A and BBB Corporate 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. As of 31 December 2020.
Sterling investment-grade bonds performed especially well, helped by the Brexit trade deal resolution. In contrast, those segments of the European investment-grade market that have been associated with negative yields continued to struggle as investors recycled their holdings into assets with a higher spread and slightly higher beta, in the expectation that there is greater potential for spreads here to compress. Supply, as expected, remained light consistent with the usual end-of-year lull.
In line with the supportive risk environment, emerging-market (EM) bonds finished December and 2020 as a whole on a solid note. Seasonally light liquidity and steady inflows were among the technical factors that drove spreads to compress at the close of the year.
December’s optimistic tone led to broad-based gains; however, it was the high-yield portion of the market that drove returns as investors continued to move down the credit-quality spectrum in search of yield. EM high-yield spreads tightened 52bps while investment-grade spreads were 12bps tighter, causing the differential to compress by 40bps1.
Within the high-yield universe, lower-quality bonds from countries such as Angola, Costa Rica and El Salvador outperformed. This was because investors reasoned that the more optimistic sentiment in global financial markets would improve the prospects of troubled issuers regaining market access and also allay liquidity concerns.
While the recent performance of lower-quality credits has been impressive, on a full-year perspective EM high yield performance lagged EM investment grade by some margin; around -1.0% and +9%, respectively1.
Local-currency EM bonds continued to build on November’s performance, helped by favourable moves in foreign exchange rates. The yield curves in lower-quality countries flattened from historically steep levels as investors searched for yield.
Emerging market bond spreads
Source: Bloomberg, JP Morgan and Vanguard. Data period from 1 January 2017 to 31 December 2020.
While the macro outlook is quite constructive due to vaccine roll-out, we feel much of the good news has already been priced-in by the market. In the near term, with risk sentiment strong and a continued accommodative central bank backdrop, we believe further, modest spread tightening is possible. Within this scenario, there is also, however, a risk that markets will overshoot in their tightening, although spreads are at their most compressed level in 10 years.
Against this background, a ‘risk-on’ reflation’ trade is a possibility, though we see few catalysts for significant spread movement in either direction. We are maintaining a reduced level of overall credit risk relative to earlier in the year, selectively positioning across the pockets of the market that should still benefit from strong investor demand and a steadily improving macroeconomic backdrop. Cyclical sectors, select Covid-19-sensitive segments and pockets of lower-quality securities offer value but security selection and comfort around issuer fundamentals will dictate our exposures.
We believe the prospects for EM fixed income in 2021 are favorable, supported by an improving macro backdrop and plentiful liquidity. Room for further spread compression in the EM high-yield segment means that EM valuations remain attractive relative to other fixed income asset classes.
We expect net external debt issuance to reduce and while a lower supply outlook, for the full year, is supportive we are mindful that a frontloaded calendar for new issuance could put pressure on spreads in the coming months. This leads us to focus on relative value and favour a tactical strategy in the near term. We would see any broad-based weakness as an attractive opportunity to add to positions.
1 Source: Bloomberg. Data as at December 31st, 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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