Multi-Sector Bonds

We have now retraced some 90% of the March widening in European high yield (on a spread basis and relative to the January tights), a recovery trend we expect to continue as economies open up and demand bounces back. 

Unlike the past six months, where nearly all new deals performed well in the secondary market, from here on in that is far from guaranteed. Expect winners and losers.

Overall, in our view there may be some temporary volatility ahead which investors can try to sidestep or even take advantage of, but it’s probably not worth trying to be too cute as our medium term outlook is still constructive.

Yesterday we showed that for European investors, what we speculated on back in March has come true; that the bond market did recover its losses far more quickly than equities, as shown below.

A trend of negative ratings migration has historically been a consistent precursor for a pick up in the default rate of publicly rated debt.

With BP slashing its dividend this week, we have now seen 52 of the FTSE 100 companies suspend or cut their dividends this year. 

Earlier this week, Moody’s published its default study for June, which showed that as expected, default rates globally have started to pick up as a result of COVID-19. The trailing 12-month global high yield default rate reached 5.4% at the end of June, up from 4.8% in May, as the gap to the long term average of 4.1% continues to grow.

Ultimately, while Q2 will be a bad quarter for many companies even if they outperform expectations, in our view it is not the real driver of spreads at this stage.

The European high yield market has shown remarkable resilience in the face of what will likely go down as one of the sharpest and most severe recessions in history. The benchmark iTraxx Xover index (a widely used proxy for Euro HY credit risk) has tightened from an intraday high of 730bp in March to 342bp earlier this week, a retracement of almost 75% from the January lows of approximately 200bp.

The European high yield sector has seen a sharp correction from its highs earlier this year, with the Crossover index moving from a tight of 203bp in January to an intraday wide of 730p on March 18 (by this morning it had also seen a retracement of around 50% to 470bp).

It has been a positive sign for us that despite lockdowns being enforced in most of the major economies around the world, in the last two weeks several issuers have managed to successfully raise new debt via the primary market.

Having started the year with low yields and tight spreads, fixed income markets had the most brutal month I can recall in March and have been repriced in the most aggressive manner imaginable. The dust does appear to have settled and a more balanced market without ‘fire sale’ pressure has returned, so we thought it was worth recapping where we are today and sharing some thoughts for the journey ahead.