“If we observe the evolution of the financial markets during 2020, the element that stands out is certainly the strong volatility recorded on all the markets, in particular the bond markets, in the first quarter of the year. At the end of March, when the financial markets were grappling with the effects of the virus that forced economic activity worldwide, we witnessed a level of volatility on the credit markets comparable to that of 2008 and 2009. The Tax and monetary authorities have reacted very energetically to this wave of volatility. ” This is what Gene Tannuzzo , Vice Director of Fixed Income of Columbia Threadneedle notes , which analyzes belowthe impact of Covid-19 on fixed income markets, finding opportunities in this sector .
Governments have certainly done a great deal to mitigate the repercussions suffered by consumers and businesses. In addition, central banks have introduced huge volumes of liquidity on the capital markets, keeping under control not only the risk-free rate, but in many cases also the credit risk premium, even going so far as to buy corporate bonds and other types of securities fixed income.
These measures have had very positive consequences as regards the stabilization of markets and liquidity, while the consolidation effects on fundamentals, which in many countries are still in a somewhat difficult situation, will inevitably be gradual. Take for example the United States, where 22 million jobs went up in smoke by the end of April, then recovered only minimally.
The economic dislocation is therefore significant. At the same time, however, the dimensions of the political response appear truly remarkable. According to our forecasts, in fact, central banks will close 2020 having injected about 6,000 billion dollars on financial markets in support of economies. After the 2008 crisis, however, the overall figure had stopped at around 3,000 billion. The scale of the policy response is therefore considerable and, in this context, risk-free interest rates have fallen close to zero or, in some cases, even below. For example, on the German government bond market, interest rates on ten-year bonds have been anchored below 1% for over five years. In the United States, they have just fallen below this threshold, but we believe they will not go back,
Caution on high yield corporate credit
The question we must ask ourselves at this point is the following: what is better to do in a situation with interest rates that remain low? For our part, we believe there are opportunities to be seized outside of sovereign markets , especially in corporate credit . In terms of risk-adjusted return, we see the best opportunities in the investment grade market , where issuers with solid liquidity profiles are available that can overcome the current turbulence and where we can count on the financial support of central banks that continue to act as support pillar on global markets.
The high yield market has less clear dynamics and, in our opinion, is more affected by the effects on the economy caused worldwide by the pandemic, so much so that our internal forecast of the default rate for this sector is 8.5% in 2020 and an additional 5% in 2021. If we are right, this means that just over 13% of high yield companies could file for bankruptcy in the next two years, compared to 4-5% of the long-term average. In such a context, the increase in non-performing cases makes the role of credit research absolutely crucial. Although the high yield market offers opportunities on both sides of the Atlantic, both in Europe and in the United States, we believe that investors should exercise particular caution in moving to identify companies that are able to overcome economic turmoil.
In addition to the corporate securities market, another area that we consider very interesting in the current context is that of structured products, in particular commercial mortgage-backed securities . These bonds, which are guaranteed by commercial assets such as hotels, offices or retail outlets, are facing serious difficulties at the moment, just think of how many tenants are struggling to pay the rent. Nonetheless, we believe that there are opportunities to be seized in cases where the asset value of the asset that guarantees the obligation is considerably higher than the debt burden: in this context, it is possible to identify opportunities with a whole price