It is hard to believe that the events that shook markets at the onset of the coronavirus crisis took place only 18 months ago. It has truly felt like a lifetime for many of us, given the level of uncertainty that the virus has brought to the world. It has also felt as if we have completed a full cycle for markets, which have so far been on a one-way path of recovery since the worst of the crisis.
Credit markets are no exception, and about six months ago we wrote how tight credit spreads were already. Astonishingly, spreads have carried on tightening relentlessly, albeit with a couple of brief bouts of market volatility.
Where are we now?
The chart below represents the range of credit spreads since 2006. When spreads are at the top of the range, closer to 100%, as they were on March 23, 2020, that means that spreads were tighter about 100% of the time compared to their levels then.
Now, spreads are at the bottom of the spectrum, with USD investment grade (‘IG’) corporates being tighter than the current levels only 3% of the time, and GBP IG tighter only 4% of the time.
EUR IG looks only marginally more attractive, but on the other hand, global high yield and emerging market debt still appear to have room to compress, which reflects the uncertainty still present in markets around COVID-19 and its long-lasting effect on global growth.
Why are credit spreads still tightening, despite an uncertain global economic picture?
First, the global stock of negative-yielding debt continues to increase, particularly in the European and Japanese government bond universe, pushing investors to look for an additional boost to return -- which they can find in credit spreads.
Secondly, for US credit, overseas demand continues to compress spreads. Given the current levels of yields and relative currency valuations, European and Japanese investors are seeking to exploit current trends by buying US-denominated debt and hedging the currency exposure back to euros and Japanese yen.
What does this mean for global credit investors?
Given how expensive investment-grade credit is at present, we are balancing underweights in certain tight markets or sectors with alternative sources of yield. At the same time, we are increasing our liquidity buffers to aim to take advantage of any unexpected market weakness, which also enables us to continue to be very nimble in our positioning.
Driven by our bottom-up analysis, we are currently seeking selected opportunities across subordinated financials, as well as in global high yield and emerging markets, given the combination of improving fundamentals (of individual companies and sovereigns), more attractive valuations and strong technicals supporting demand in those markets.