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July 2019

The Interaction of Growth and Policy

Expectations for easier monetary policy in response to weaker growth prospects have given rise to three key market themes among fixed income spread sectors, including corporate credit.

Theme I: Outperformance of Fixed versus Floating Rate Assets

Investors have rotated out of floating rate assets such as bank loans this year in light of anticipated monetary easing, while fixed rate assets such as high yield bonds have regained favor. As a result of changed investor preferences, fixed rate assets such as high yield corporate bonds have outperformed floating rate securities such as bank loans and collateralized loan obligations (Exhibit 1).

Exhibit 1 Fixed rate assets are back in favor

Fixed rate portfolio: B-, BB- and BBB-rated corporate credit; Floating rate portfolio: AAA-rated CLOs and B- and BB-rated bank loans

Source: Macrobond, GSAM. Bank of America Merrill Lynch Corporate Indices, J.P.Morgan CLO index, Credit Suisse Loan Index. As of July 29, 2019.

Theme II: Outperformance of High versus Low Quality

Although high yield bonds have outperformed their floating rate peers, within the corporate space they have underperformed investment grade. More broadly, across spread sectors, lower quality assets have underperformed higher quality counterparts (Exhibit 2). This is due to downbeat growth prospects, largely centered on political risks such as the US-China trade war and an unresolved Brexit.

Exhibit 2: Quality divergence

High quality portfolio: A-rated investment grade corporate credit, BB-rated high yield corporate credit and investment grade emerging market (EM) sovereign and corporate debt.
Low quality portfolio: BBB-rated investment grade corporate credit, B- and CCC-rated high yield corporate credit and high yield EM sovereign and corporate debt.

Source: Macrobond, GSAM. As of July 29, 2019. Bank of America Merrill Lynch Corporate Indices, J.P. Morgan EM Indices.

Theme III: Outperformance of Euro versus US Dollar Credit

A contraction in global trade flows has weighed on open economies that run a trade surplus such as the Euro area. In response, the ECB looks set to deliver a policy easing package at its September meeting that includes resumed asset purchases. Expectations for a return of quantitative easing combined with a continued search-for-yield has helped euro-denominated corporate bonds outperform their dollar-denominated counterparts (Exhibit 3).

Source: Macrobond, GSAM. As of July 29, 2019. Bank of America Merrill Lynch Corporate Indices.

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