1. Macro: The COVID-19 Pandemic
A rapid rise in COVID-19 cases beyond China in March led to a sudden stop in global economic activity and a sharp selloff in financial markets. Through the year, the pandemic gave rise to risk premiums; that we sought to capture based on our view that the market differentiated sectors based on COVID-19 sensitivity but did not always accurately distinguish underlying issuers based on corporate fundamentals.
2. Markets: Acute Illiquidity
A sharp deterioration in risk sentiment in credit markets was induced by growing downside risks to growth as well as a collapse in oil prices. At the height of market uncertainty, the US corporate market rapidly shifted from a well-functioning and relatively liquid market to one in which liquidity had dried up faster and more severely than during the global financial crisis.
3. Macro: Fed Facilities
On March 23, the US Federal Reserve (Fed) unveiled its Corporate Credit Facilities. This helped US credit market liquidity return just as fast as it had previously dried up, even before purchases commenced in June. The Fed now owns more than $14bn of corporate bonds, though its pace of purchases has fallen sharply since the summer and remain modest. Nonetheless, since the Fed announced it would purchase corporate bonds, US investment grade and high yield corporate bond markets have delivered cumulative excess returns of 20% and 28%, respectively.
4. Macro: Growing ECB Footprint
The European Central Bank (ECB) now owns more than 8% of the European investment grade market, expanding its holdings by €272 billion this year through its corporate sector purchase program (CSPP) and pandemic emergency purchase program (PEPP). This is an estimated 23% of the eligible universe of securities. Dovish policy guidance implies the ECB’s presence in European credit markets will remain a strong demand tailwind into 2021.
5. Markets: Expansion of Negative Yields in Europe
Ultra-easy monetary policy has extended the challenge of negative yields in European bond markets. Around 41% of the European investment grade index is now in sub-zero territory, on par with a prior record reached last August. Furthermore, 10% of the market provides a yield that is below -25ps. We expect the negative yield backdrop to strengthen search-for-yield motives next year.
6. Markets: Negative US Real Yields for the First Time
For the first time, real yields for US investment grade corporate credit have turned negative, highlighting that negative yields are not confined to Europe. We expect inflation to remain subdued due to economic and labor market slack. Nonetheless, negative yield yields raise the risk that an upside inflation surprise could create challenges.
7. Markets: Fallen Angels, Higher High Yield Quality
The first quarter of 2020 saw record-high volumes for fallen angel downgrades from the US investment grade market, with over $150 billion entering the high yield sector. A further $81 billion of downgrades occurred in the remainder of the year. In Europe, fallen angels totaled €37 billion in the first quarter, followed by €43 billion in the subsequent quarters. Alongside high yield defaults, these downgrades improved the average quality of the US High Yield market, with the share of BB-rated bonds rising from 46% of the index to 55%. In Europe, this rating cohort—the highest quality within high yield---amounts to 67% of the market.
8. Markets: Record Issuance
Corporate issuers took advantage of the low yield environment in 2020, with gross new issuance volumes in the US reaching a record $1.95 trillion and $414 billion in investment grade and high yield markets, respectively. Remarkably, even high yield-rated companies in sectors highly exposed to COVID-19 disruptions were able to access public debt markets for funding. This new issuance activity has led to a significant increase in cash on US nonfinancial corporate balance sheets. We will be closely monitoring how companies utilize this cash in 2021.
9. Markets: Rapid Drawdown, Rapid Recovery
The onset of the pandemic was met with fast, bold and broad policy stimulus. This resulted in both a rapid drawdown and rapid recovery in corporate credit markets. Spreads have compressed considerably from 2020 highs and will enter 2021 at levels slightly above where they closed 2019.
10. Macro: Vaccine Discovery
COVID-19 case growth dominated news flow at the start of the year but encouragingly, rapid vaccine discovery and the start of immunizations has helped lift sentiment into year-end. We expect virus spread to slow growth over the winter months before economic recoveries reaccelerate in the spring as mass immunizations allow the job-rich services sector to recover. Added growth supportive factors include accommodative macro policies and limited evidence of permanent economic scarring. We expect this cyclical uplift to support search-for-yield motives and risk sentiment in 2021. As credit spreads further compress, we believe management of credit risks and ESG factors that can present material downside risks will become increasingly essential. In addition, we are mindful of lower quality and less cyclical portions of the credit market that may not benefit from growth improvements.