Year 2020 in review: credit markets

Global financial markets certainly did not lack drama in 2020.

The coronavirus pandemic, breaking up of the OPEC+ agreement, substantial monetary and fiscal stimulus packages, U.S. presidential election, and lastly the highly anticipated developments on coronavirus vaccine trails, were the main topics which drove financial markets.

Indeed, the European Central Bank (ECB) and Federal Reserve (Fed) intervention proved crucial.

Mounting uncertainty surrounding the coronavirus pandemic and ensuing economic disruptions, led Christine Lagarde, four months into her new role, to unveil a new asset purchase programme; the Pandemic Emergency Purchase Programme (PEPP) – aimed to counter; the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the Covid-19 outbreak.

Similarly, the Fed, in addition to slashing the target interest rate to near zero to support the economy during the coronavirus pandemic, unveiled new quantitative easing measures. This, in a bid to avert a full-blown financial crisis.

Following a subdued period, characterised by lockdowns and movement restrictions bringing activity to a halt, economic data showed signs of a recovery. Following such an encouraging period, the coronavirus pandemic took a turn for the worse over the fourth quarter. New infection rates across Europe and the U.S. soared, topping previous highs, and prompting an urgent effort. Once more, governments were left with no option, but to re-impose movement restrictions to curb the spread of the deadly virus.

To mitigate the economic effects of the second wave of coronavirus infections, central banks once more intervened.

The ECB extended and propped the initial €750 billion figure to a total of €1,850 billion while the Fed pledged to maintain its bond-buying programme, by at least $120 billion each month until substantial progress is made toward the committee’s maximum employment and price stability goals.

Sovereign yields

Following a spike at the pandemic’s peak, sovereign yields – mainly conditioned by monetary intervention thread lower.

The ECB’s continuous efforts led bond yields of the bloc’s ‘periphery’ – those which offer a premium over Germany’s deeply negative-yielding debt, to significant lows, some, also breaching the zero per cent mark. Notably, Portugal’s 10-year bond yield reached a record low of -0.06%.

After a significant drop in Q1, U.S. treasuries often considered a safe-haven and thus sought after in times of crisis, although witnessing a degree of divergence during Q2 and Q3, traded within a narrow range. It was only until Q4 when U.S. treasuries buoyed by optimism on; positive economic data, promising vaccine developments, and that a deal can be reached on a new U.S. coronavirus relief package edged higher. The benchmark 10-year Treasury yields closed the year 97 bps lower at 0.91%.

Corporate credit market

Growing concerns about corporates’ ability to service their debt at the peak of the unprecedented Covid-19 pandemic led to substantial widening (reaching significant highs of over 1000bps). However, ensuing such period of rising economic uncertainty, a credit spread reversal was expected. This, particularly on the notion of; monetary intervention by the respective central banks allowed corporates to refinance, fiscal intervention by the respective governments, and subsequently, the news surrounding the coronavirus vaccine trials. The latter, outweighing uncertainty and leading to a sector rotation.

Ultimately, the sectors which proved more vulnerable at the peak of the pandemic, overall, outperformed.

Automotive: Auto manufacturers were cautiously navigating a landscape of tenuous global demand before pandemic concerns disrupted worldwide production and upset supply and demand. Although the impact on consumption was severe when the pandemic hit, robust balance sheets allowed most automakers to navigate a di?cult 2020 safely.

While sales figures have generally remained lower compared to pre-pandemic levels, a stronger-than-expected recovery across Europe, but more remarkably so in China, led to substantial credit spread tightening.

Banking: Albeit significantly dragged during Q1, banking institutions – forced by regulators to be adequately capitalised and prepared for such unprecedented scenarios, witnessed substantial tightening there-on. Better-than-expected results, improved capitalisation, and declines in non-performing loans proved supportive.

Credit spread tightening deepened in the Q2 and Q4, as the economic outlook showed signs of improvement.

Energy: WTI Crude – strongly depressed at the beginning of the year, following the breaking up of the OPEC+ agreement, registered substantial gains as vaccine optimism boosted hopes for a sustained recovery in economic activity and ultimately, energy demand.

The upward move in crude prices, correlated to the improved macroeconomic conditions led to significant spread tightening.

As conferred, central bank monetary intervention and government-led economic stimulus measures have in 2020 proved instrumental to safeguard the corporate credit market.

We believe that the central banks will be keen not to disrupt the economic recovery we have witnessed in 2H 2020, by maintaining an accommodative stance throughout H1 2021. This, by holding interest rates at relatively low levels while maintaining its asset purchase programmes. Additionally, governments shall prove supportive through both fiscal incentives and infrastructural investment to speed up an economic recovery. While the latter two shall prove supportive and possibly lay the foundation for a quicker economic recovery, coronavirus immunisation is crucial.

Going forward, we believe that the downward reversal in yields, envisaged in recent months, shall continue to prevail through 2021. We are less constructive on government bonds given possible inflationary threats, which may ultimately also disrupt the investment grade space. In this regard, given a lower sensitivity to inflation, we are more constructive on the more speculative tranche: the high yield space, also on the basis of an improved economic outlook. Meanwhile, we believe that coronavirus-sensitive sectors shall in 2021 continue to outperform given no disruptions to the vaccine roll-out.

Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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