Market normalisation is underway, supported by the rising probability that the Federal Reserve will carry out yield-curve control and a better-than-expected recovery in Purchasing Managers Index readings. Earlier this year, the dual shock of the oil-price crash and coronavirus crisis encouraged institutions to hoard cash and resulted in the greatest liquidity squeeze in a decade.
Markets responded in typical fashion to the decline in liquidity condition: credit curves inverted and both bonds and higher-quality credit underperformed (the latter on a beta-adjusted basis).
Since then, the primary market has reopened and even businesses exposed to the pandemic shock have been able to access funding, causing credit curves to steepen again (see figure 1). Earnings season gave investors an insight into the impact of the crisis on cash-flow generation, as well as what tools firms have to navigate the uncertainty, meaning that high-quality credit started to lead the market recovery.
Figure 1. Curves start to steepen
Source: Federated Hermes, Bloomberg, as at June 2020.
The relationship between the synthetic and cash markets has also largely normalised. Primary issuance has increased as companies hurried to take advantage of the positive climate and improve their liquidity position. This has resulted in strong flows into global credit markets as investors start to see the benefits that the asset class has to offer in the current environment.