After a period of strong market performance – particularly for emerging-market credit – both realised and implied volatility increased last week, and high-yield credit experienced its largest drawdown since March.
Markets tend to focus more on future expectations than spot fundamentals. As a result, they often lead recoveries, which can lead to bouts of volatility as poor news – the threat of a second wave of infections or slower-than expected lockdown easing – scales back expectations.
Nonetheless, the re-opening of the global economy is on track and the latest data coming out of the US inspires confidence. This, combined with improved technicals on the supply side and companies front-loading issuance ahead of the US election, should support markets over the coming months.
Moreover, central banks seem committed to flexibly adjusting stimulus in response to evolving market conditions. For example, the Federal Reserve (Fed) recently tweaked its Purchase Programme to remove the need for self-certification – something that should support issuers with a large amount of front-dated maturities (many of which are fallen angels, or issuers downgraded from investment-grade status).
Fallen angels have outperformed recently, boosted by the lack of growth in the high-yield universe over the past five years and the Fed’s commitment to support this part of the market (see figure 1). The latest change to the Fed's stimulus plans will support fallen angels further, ensuring they continue to lead the recovery as the rest of the market tentatively follows.
Figure 1. Fallen angels charge ahead
Source: ICE Bond Indices, Federated Hermes, as at June 2020.