Expectations about interest-rate volatility have declined, bolstering the reach for spread among investors. This has also translated into lower realised volatility within investment-grade credit, which has returned to the average level seen over the last decade (see figure 1).
Figure 1. Realised volatility in credit markets
Source: ICE Bond Indices, as at September 2020.
This is not surprising. The first half of the year saw the largest credit-market sell-off in history, which forced the European Central Bank to enlarge its stimulus package and the Federal Reserve to support the corporate-credit market – in particular fallen angelsand the front end of the curve – for the first time in history.
Central banks have few cards left to play, but the flexibility we have become so used to is likely here to stay – something that was driven home by Federal Reserve Chair Jerome Powell’s recent comments on average inflation targeting.
Yet volatility remains elevated within the high-yield universe. Asset allocators are cautiously positioning themselves for the recovery, preferring to avoid high levels of credit risk and instead looking to the hybrid market for exposure to the subordination premium.
Going forward, a strong reopening of the European primary market – particularly for new names and leveraged buyouts – and continued primary-market access for unsecured CCC-rated credits in the US will be key to determining whether volatility declines in the high-yield part of the market.