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April 2020 | GSAM Connect
What’s been happening in credit markets?
Lots of New Supply. US investment grade supply amounted to an all-time monthly high of $265bn in March. The primary market has remained busy in April and year-to-date new issue volumes are in excess of $710bn. This marks the busiest start of a year during the post-financial crisis period. Economic uncertainty and a conducive demand backdrop (supported by central bank quantitative easing programs) will likely result in continued proactive issuance as companies seek additional liquidity. In March, many companies utilized bank facilities such as revolvers, though this activity has tapered off in April as primary market activity resumed. Lower borrowing costs are an added factor for new issuance. The US market yielded 2.84% at the start of the year; yields are currently at 2.71% and fell to a historic low of 2.22% on March 6. The pace of European investment grade supply has also been high relative to recent years but less elevated relative to the US dollar market. In Europe, we also see increased reverse Yankee issuance (i.e., Euro-denominated debt issued by US-based firms). By contrast, new supply in high yield markets has been relatively muted. New supply has recently picked up in the US but remains low relative to investment grade, and is more-or-less dormant in Europe, though we have seen a few new issues in recent weeks, including one from a fallen angel.
Q1 Earnings Releases. We are in the midst of first quarter earnings releases and we expect COVID-19 to dominate both earnings and management commentaries. Many companies have reported a drop in demand and growth from the start of March, reflecting the imposition of activity restrictions. Corporates in sectors benefiting from raised consumer demand, including Consumer Staples and Telecommunications, are reporting stronger results than those in virus-sensitive sectors including Airlines and Hospitality. We will review key takeaways in detail next month.
“Do Whatever It Takes” Central Bank Support. Both the US Federal Reserve (Fed) and European Central Bank (ECB) will catch fallen angels (investment grade companies downgraded to high yield). On March 23, the Fed announced it will buy corporate bonds as part of its quantitative easing (QE) efforts. On April 9, it expanded the size and scope of the program, announcing it will buy BB-rated bonds of recent fallen angels so long as they were investment grade rated as of March 22, 2020. The ECB will accept high yield bonds from banks as collateral for loans, providing the bonds were investment-grade rated as of April 7 and remain BB-rated. The Fed’s corporate bond buying operations have not yet commenced. However, similar to what we observed in 2016 when the ECB ventured into corporate bonds, words speak louder than actions, with US corporate bond spreads unwinding 60% of the widening observed between mid-February and March 23.
Normalization in the spread between credit derivatives and cash bonds. In both investment grade and high yield markets, the spread between credit derivatives and cash bonds fell sharply in March amid market volatility, with low liquidity (discussed last month) resulting in more pronounced spread widening in cash bonds. Fed programs to address market stresses have resulted in derivative minus cash bond basis compression, though it remains wide by historical standards. We have opportunistically participated in new bond issues to rotate our credit exposure out of credit derivatives, where valuations are extended, and into cash bonds.