Credit: expectations and favourite themes
Credit spreads should return to pre-covid levels by end-2021 as the roll-out of vaccine programmes could kickstart a new recovery credit cycle. Investment-grade (IG) bonds should continue to trade around current yield levels as core sovereign yields have limited upside potential, but high-yield (HY) bonds spreads could tighten further in the coming months. Lower-rated HY bonds are still facing solvency risks despite recent market optimism. However, having prioritised the health of their balance sheets, a majority of corporates is in a relatively secure position in terms of liquidity and solvency prospects. This defensive behaviour should continue.
Market exuberance means that credit spreads could tighten further in the coming months. This could be especially true for HY. However, looking across sectors, companies’ fundamentals will likely only fully recover in 2022 at the earliest, meaning that H2 21 could see some renewed spread widening as market participants adjust their expectations.
Overall, we remain neutral on US IG corporate bonds, but in late November we moved to underweight on euro-denominated IG credit in view of low total return prospects, as yields are close to zero. HY looks relatively more attractive, but spreads are likely to be volatile until we have a clear roll-out path for vaccines. We also moved from underweight to neutral on euro HY, which may offer slightly higher total returns than US HY thanks in part to a lower default rate.
2021 will be a bond-picker’s year, just as in 2020. From a fundamental standpoint, we have three main themes. First, we prefer to head down the capital structure of quality companies rather than look for similar yields in bonds of lower-rated HY companies. Second, we like to extend spread duration to gain extra yield, particularly in defensive names with steep curves. Last, we are selective in our credit choices to play the recovery story. We are favouring sound credit names and/or those with improving fundamentals as opposed to names that offer superficially attractive yields.