Over the past few months, a confluence of positive factors has buoyed market sentiment and significantly reduced market expectations of future volatility. The gradual re-opening of the global economy and progress in developing a vaccine have increased the prospect of an eventual recovery.
Combined with a cut in oil output, these factors have improved the supply and demand imbalance and the price of oil has recovered from its lows. But recovery is a gradual process. In recognition of this, asset allocators have identified credit as an attractive asset class.
This can be seen by flows into mutual funds and exchange-traded funds, with both European and US investment grade and the US high-yield market recording positive flows year-to-date. In turn, this has been supported by strong primary-market activity across those parts of the market and has improved the fundamental picture for issuers who are able to pre-fund upcoming maturities and accumulate additional liquidity.
This has helped investment-grade curves steepen again and has assuaged fears about the ability of investment-grade corporates to refinance upcoming maturities. Under the surface, the market recovery is mirroring that of the 2008-9 crisis, when higher-quality credit led the way after suffering in the first stage of the sell-off.
Earnings season is also in full throttle, as investors continue to differentiate between companies that are better positioned to withstand the coronavirus crisis, and those that have few options at their disposal.
On the back of this, higher-quality companies have materially recovered from the lows experienced this March, while lower-quality companies are still hovering around the bottom (see figure 1). This suggests that credits with a dire fundamental outlook are receiving limited sponsorship.
Figure 1. High-quality credit starts to outperform
Source: ICE Bond Indices, as at May 2020.
With the largest-ever monthly rebalancing behind us – and this year’s first earnings season drawing to a close – we will likely see in the coming weeks a continued focus on bottom-up fundamentals and sector-specific dynamics. For our latest views on the metals and mining sector, watch our latest Credit Industry Insight video.