The pandemic has prompted an unprecedented reaction from central banks across the globe, which has resulted in a convergence between interest rates across different jurisdictions and a consensus that policies will be lower for longer for the foreseeable future. Expectations about interest-rate volatility have also fallen to the lowest on record (see figure 1).
Figure 1. Volatility expectations tick down
Bloomberg, as at July 2020.
By reducing funding costs for companies, the Federal Reserve seems to have convinced markets that it will do whatever it takes to keep the economy afloat. As we recover from the worst first half of the year in global credit markets, sentiment has improved and many investors are looking to corporate credit to express a view on the improving economic outlook.
Demand for investment-grade credit is strong and its yield recently fell from a multi-year high of 3.7% to 1.56%, an all-time low. Investment-grade credit has also outperformed on a relative basis, meaning that the spread ratio of high yield over investment grade has moved above its historical average. In addition, there has been a record amount of investment-grade issuance and flows into the asset class.
Going forward, there is a chance that earnings season, the US elections or second wave-induced lockdowns could derail the recovery in sentiment. But if the market recovery holds up, it is likely that investors will continue to turn their attention to BB-rated credit and the fallen angels that have descended from investment-grade status.
