Knowledge. Shared Blog

May 2020

Fixed Income Update: Credit Markets, Government Bonds and Inflation

Co-Head of Strategic Fixed Income Jenna Barnard provides an update on credit markets – noting that the tsunami of new issuance since mid-March appears to have peaked – and offers insights on government bonds and inflation.

Key Takeaways

  • The tsunami of new issuance in credit markets appears to have peaked and credit spreads have held up well, with only modest widening from the tight levels seen in April.
  • When considering government bonds and duration, we would caution investors not to confuse price volatility coming out of the current crisis with a real inflation cycle.
  • We think inflation could distract investors from the big challenge they will face over the next five to 10 years – a lack of reliable income – and believe that selective corporate bond investing could help fulfill that need.
View Transcript

Jenna Barnard: This is a brief weekly video update from John and myself. If we start with credit, I would say credit spreads have actually held up remarkably well in the face of, really, a tsunami of issuance, record-breaking investment-grade issuance, and pretty healthy high-yield issuance as well. That has been going on now since mid-March when the market reopened. And, as I said, credit spreads have absorbed that supply with only very modest widening from the April tights. That now looks to have peaked. We think last Monday [May 11] was the peak in investment-grade supply, and we think it could actually taper off pretty quickly. May always used to be a very high month of issuance seasonally. We are pushing $1 trillion of investment-grade issuance; most estimates are about $1.5 trillion through to year end, and the pace will naturally slow. You know, most companies have raised a war chest of liquidity to get them through even potentially a second wave of this virus in the autumn. So that is probably the only meaningful news in credit markets.

Then if we turn to government bonds and duration, I think the primary question that John and I keep receiving is, “What about inflation? Is it about to take off?” And the one thing we would caution here is to not confuse price volatility coming out of a crisis like this with inflation, an inflation cycle, which requires a mechanism to be self-sustaining. Prices go up, wages go up, prices go up again. If you remember coming out of the ‘08/’09 crisis, the UK did record CPI headline inflation of over 5% in late 2010 into 2011. That was a function of base effects, so very low inflation readings the year before, commodities bouncing and some currency depreciation also feeding through. The Bank of England did not hike in response to that CPI print of over 5%, and ultimately, inflation petered out and we ended up with a very low print in the next year. So price volatility, yes, we can see price volatility after a crisis like this, and very weak inflation readings this year, but an inflation cycle – no, we are not in that camp whatsoever.

And I would caution against this obsession with inflation distracting investors from the big issue or big challenge of the next five or 10 years, which is a lack of income. Interest rates are on hold for years and central banks have been very clear about that. One high inflation print does not make up for a decade of undershooting inflation before this deflationary crash you are in at the moment.

So credit, we think … we are actually quite positive given the new issuance peak. Government bonds are washing around in quite a kind of low-yield range. We caution investors about confusing price volatility with a real inflation cycle. We think the primary need in the next five to 10 years is going to be a reasonable, sensible income that you can trust. And that we think you get from select corporate bond investing.

And with that, thank you and good luck out there.

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