29 April 2021
Record-low CCC yields
In a positive environment for risk assets, CCC-rated bond yields in the US have reached record lows, while yields in Europe have also come down materially. We assess whether this can continue.
Data continues to indicate that developed market economies are well on their way to recovering from the fallout caused by the pandemic. Q1 earnings are off to a strong start, while April is another solid month for purchasing managers’ indices (PMIs), with eurozone, US and UK manufacturing PMIs surpassing expectations and reaching their highest levels on record (63.3, 60.6 and 60.7, respectively). Services PMIs are also beginning to show signs of a rebound. The question is whether markets are already fully pricing in this recovery. Distressed credits are now few and far between in high yield indices: only 0.75% of the US market and 0.24% of the European market are trading at distressed levels (with a cash price below 80). As a proportion of the US HY market, bonds rated CCC and lower stood at 15.0% in June 2020 but have fallen to 12.7% now. In Europe, they accounted for 9.0% at the peak, vs. 7.2% today. We expect default rates to continue to come down from their recent peak of 6.33% in the US and 3.75% in Europe, with CCC spreads seeming to support this view. Meanwhile, we continue to witness ample support for CCCs in the primary market, evidencing investors’ willingness to lend to low-rated corporates. (Data as at 27 April 2021.)
CCCs have had a promising run: up 41.7% in the US and 49.9% in Europe since the end of Q1 2020. Base rates and tightening spreads both contributed, such that US CCC yields hit a record low of 6.81% in April. In Europe, CCC yields stand at 6.51%, having made significant strides towards the record low of 5.03% reached in November 2017. However, with a consensus view that government base rates will now gradually rise, is there still scope to pick up attractive carry in CCCs? Valuations are trading much tighter than their average levels, but we believe this could persist for a while longer as volatility is extremely low, which bodes well for CCCs in a carry environment. There will of course be idiosyncratic risks, so active credit selection will be important. (Data as at 27 April 2021.)
CCC yields are at all-time lows in the US and are approaching their lows in Europe
Gross supply has been elevated so far this year in the high yield market: the US has printed just shy of USD 200 billion of new issues year to date (as of 23 April), whereas at this point last year issuance stood at USD 100 billion. Europe has printed EUR 56 billion of HY bonds (as of 26 April), more than half of last year’s EUR 103 billion of total issuance. The supply has been easily digested though. Retail US and European HY funds have experienced outflows of USD 8 billion and USD 1 billion respectively YTD (as of 27 April), with each equating to roughly 2% of AUM, but flows have turned more positive recently. Demand for the asset class’s yield from other sources is also supportive. Unconstrained and investment grade funds have seen strong inflows YTD (USD 44 billion collectively), and have been utilising their high yield buckets. The European Central Bank continues to own eligible HY corporate bonds that were purchased before they lost their IG ratings.
What does this mean for fixed income investors?
As CCC valuations start to touch uncharted territory, it’s no surprise that investors have started to question their sustainability. Longer term, we expect yields to rise, mainly due to underlying base rates. However, we think the spread component should hold up well until volatility picks up. With fewer names expected to default, but with less room to rally further, CCC performance could become more dependent on idiosyncratic events, rather than generalised spread tightening, potentially creating opportunities for active investors. CCC risk could still outperform, but now is the time to be selective.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum