Search this website. You can use fund codes to locate specific funds

Weekly Credit Insight

Chart of the week: the low-yield environment has depressed coupons

Lacklustre global growth, persistently low inflation and geopolitical uncertainty all mean that interest rates now sit at record lows in many countries. It is likely that policy rates and government-bond yields will stay relatively low until there are signs that economic activity is improving in a meaningful way.  

Over the past year, US 10-year government-bond yields have fallen from 3.25% to 1.5%. And in Germany, yields have declined from 3.5%-4.5% before the financial crisis to around zero this year. Because of this, coupons across global credit markets have plummeted and now stand at all-time lows (see figure 1).

Figure 1: Coupons fall across credit markets

Source: Herme Credit, ICE bond indices, as at December 2019.

This has had several knock-on effects. Firstly, refinancing debt with lower coupons has had a positive impact on fundamentals. Record-low coupons improve coverage ratios and reduce pressure on cash flow, meaning companies have more headroom to avoid defaults. As long as companies are proactive and manage the maturity wall, default rates should be lower during the next recession.

But lower coupons also make it harder for investors to recover from the high volatility that tends to come with lower-quality credit. This, coupled with the fact that weak covenants mean that recoveries will likely be lower during the next downturn, has led to decompression. The B and CCC-rated sections of the market have underperformed BB-rated securities, as investors favour issuers that have the means to withstand volatility.  

In this environment, it is more important than ever to manage fixed-income characteristics like convexity. The call price is linked to the coupon on a bond, which means that lower coupons result in depressed call prices. At Hermes, we believe that an unconstrained approach to high-active-share credit investing can help navigate these difficulties and seek the upside even in a low-rate environment.

More Insights

Credit: Industry Insights
This week, Ilana Elbim, Senior Credit Analyst, asks: has the coronavirus crisis simply accelerated trends already in motion in the retail sector?
Weekly Credit Insight
In an atmosphere of uncertainty, dispersion between high and low-quality credit has risen.
Building back better: why climate action is key to a resilient recovery
Why stimulus measures should be combined with efforts to tackle climate change
Fiorino: in this pandemic, asset quality is key to banks' health
In this launch issue of our Fiorino blog, we assess how banks are preparing for corporate defaults resulting from lockdowns across economies worldwide.
Gemologist: can we adapt to a new climate normal?
Climate change will test our ability to avoid mortal danger more than ever before. Humanity’s ability to adapt, something we have excelled at, must again come to the fore.
Portfolio triage: Market Risk Insights, Q2 2020
Just as overstretched hospitals triage critical patients, investors must triage the risks to their portfolios and prioritise them.