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

Views from the credit desk: Bullish and Bearish Cases
In our latest Credit Pulse we consider the case for bullishness and bearishness about corporate conditions and the global economy, and suggest ways that credit investors can act on either sentiment.
Looking below the surface: 360°, Q2 2021
What is our current view of fixed income markets? And where do we see the best relative value?
The Circular
The Circular cuts to the heart of the issues that matter in the second ESG quarterly update for 2021...
Infinity and beyond banks: the never-ending battle between old money and big tech
Fiorino examines the tussle between banks and the increasingly belligerent Big Tech sector.
Supporting Business at its Best
Celebrating inspiring stories from UK businesses making a difference
Credit Pulse: market update – 21 May 2021
In this latest dynamic debate in our Credit Pulse series, we ask: What is the bull case for markets versus the bear case? How cautious do investors need to be?