Playing the primary market
Both governments and central banks have delivered sizeable fiscal stimulus packages and quantitative easing programmes—and there’s talk of even more to come. What’s the next step in the pandemic playbook, and are there opportunities for fixed income investors?
Now that we have seen the monetary and fiscal policy response, we need to see the virus response: namely, evidence that strict containment measures are helping to slow the spread of the virus and that economies are able to re-open without a resurgence in infections. China can act as a road map for the rest of the world, though services-based western economies may face more challenges than manufacturing-oriented China. To understand the depth and length of the imminent recession, we are monitoring indicators of long-term scarring, including job losses and corporate bankruptcies. Thus far, these do not bode well: in the US, initial jobless claims rose to 3.28 million for the week ending 21 March, significantly outpacing the weekly peak of 665,000 reached during the financial crisis. These economic realities are prompting forecasters to adjust their estimates for the likely depth of the recession, with second-quarter real GDP now expected to fall by 10% or more in many developed markets.
With two key pillars of support in place, namely the US fiscal package and the Federal Reserve’s decision to buy corporate bonds, improved investor sentiment drove strong financial market performance in the final stretch of the first quarter. Having widened more than 500 basis points (bps) to reach 1,094 bps on 23 March, global high yield spreads tightened almost 200 bps for a 7% total return in the week to 31 March. The US investment grade credit market has also experienced a meaningful rebound, returning 8% since the year-to-date peak in spreads of 373 bps on 23 March. Importantly, the “easy” rebound has now happened, and we do not expect this tightening to persist in a straight line without a fundamental catalyst. (All data to 31 March 2020).
Unparalleled demand for bonds is being matched by unparalleled supply
Monetary and fiscal policy measures are having an important impact on bond market technicals. Unparalleled demand for government and high quality corporate bonds, from central bank purchase programmes, is being matched by unparalleled supply. In the government bond space, new issuance is being used to fund countries’ growing fiscal deficits, while corporates that have typically used the commercial paper market for near-term funding needs are increasingly turning to the bond market to shore up financing for longer periods of time. As a result, March was a record month for new issuance in the US investment grade credit market, with gross supply totalling USD 260 billion. This dynamic creates opportunities for bond investors to selectively play the primary market and benefit from new issue concessions, which, in some cases, have been in the order of 50 to 100 bps in the US corporate market and over 10 bps in the government bond space.
What does this mean for fixed income investors?
We continue to favour assets that are in high demand from central banks, including core government bonds and high quality credit. We believe the primary market—which has been particularly active—offers an efficient way to access this paper, as deals are coming at attractive levels. However, selectivity remains crucial, as it will be vital to distinguish the issuers that could face a solvency crisis as a result of the economic downturn. Before we see an opportunity to fully re-engage in risk markets, we will need evidence that economies are able to resume normal activity levels—which still seems some way off.