The shape of credit curves is one of the key areas we monitor for a sign that markets are returning to normality. This indicates how much companies have to pay (over the price of government bonds) to raise debt in different maturities.
Heightened uncertainty and record levels of volatility encouraged institutions to focus on raising liquidity. In the first instance, this was done by selling the most liquid part of the market: Treasuries, commercial paper and front-dated investment-grade securities. At the peak of market stress, this prompted investment-grade curves to invert and one- to three-year bonds recorded higher spreads than seven- to 10-year bonds (see figure 1).
Figure 1. Inside out: credit curves invert
Source: ICE Bond Indices, as at May 2020.
Since then, credit curves have normalised and returned to levels seen before the coronavirus crisis. In particular, the Federal Reserve’s (Fed’s) announcement that it would support the front end of investment grade through both primary and secondary programmes – and include fallen angels, or credits downgraded to high-yield status – supported this segment of the market.
Building on this momentum, the primary market for higher-quality investment-grade issuers (rated BBB and above) has reopened and there has been a record amount of issuance. Access to the primary market means that these corporates will be able to finance front-end maturities. For some issuers, this also gives them the ability to repay the revolving credit facilities that they drew on to weather the liquidity crisis.
Looking to more technical factors, a record number of fallen angels have entered the high-yield market over the past month. Fallen-angel issuers tend to have the flattest curves, given that there is much lower demand for one- to three-year bonds in the high-yield market. This usually results in some indigestion when a large amount of front-end maturities descend into the high-yield market. As they exit investment-grade benchmarks, the curves naturally steepen.
Given the challenging macroeconomic conditions, the absolute level of funding costs has remained high. Nonetheless, curves continue to normalise. This will continue as the Fed’s programmes get underway and it joins the European Central Bank (ECB) in supporting the funding market for corporates.
In Europe, a key sign of normalisation will be if the new-issue market opens for high-yield borrowers after earnings season. If it fails to, the ECB may need to increase its direct support for the high-yield market.