Many Marvels: The Year In Corporate Credit

One the many marvels of 2020 was the US corporate bond market, where borrowers were able to access cheap money in record amounts despite (or because of, depending on how you want to conceptualize things) the worst economic downturn in a century.

When the lockdowns began in March, credit markets convulsed. Spreads ballooned wider, CDX exhibited multi-standard deviation moves, outflows accelerated, and popular ETFs looked to be on the brink of “breaking,” as big discounts to NAV suggested the underlying liquidity mismatch in retail credit products was finally being exposed as an untenable flaw (figure below).

Ultimately, the Fed stepped in on March 23, and then, just days later, unveiled a backstop for fallen angels and high yield ETFs.

The rest, as they say, is history. With the Fed effectively guaranteeing anything that could even loosely be described as “investment grade,” credit recovered — and right quick, too.

Outflows turned to inflows and NAV discounts to premiums. On Lipper’s data, there was but a single weekly outflow in investment grade credit funds since the Fed backstop turned the tide. The last week of 2020 was another blockbuster, with IG funds taking in nearly $6 billion.

High yield flows recovered as well, although there were some “missteps” during the September selloff in equities.

Eventually, both investment grade and junk bond yields hit record lows. That, despite worries that credit is uniquely vulnerable to any structural damage from the pandemic. Changes in consumer preferences that turn out to be permanent, for example, could mean that some business models are dead — forever.

That prospect — that the “scarring” effect isn’t properly quantified, namely because it can’t be known ahead of time — makes elevated leverage seem precarious.

The proliferation of “zombies” was a hot topic in 2020.

I have, of course, buried the lede, even as all of the above alludes to it. The biggest story in credit was record issuance. By my data and math, the final numbers for 2020 show IG issuance of nearly $1.75 trillion and high yield borrowing coming in at about $432 billion.

That is an astounding set of visuals, especially considering the economic backdrop and the acute uncertainty about what’s ahead for corporates in the post-pandemic world.

“High grade credit issuance will fall sharply from the record 2020,” BMO’s Daniel Krieter and Daniel Belton wrote, in their year-ahead outlook published in December.

That’s a technical tailwind (i.e., a bullish catalyst) for spreads, especially in an environment where the US high grade market pays out almost 40% of yield income despite comprising just 13% of the global IG fixed-income world, according to BofA’s Hans Mikkelsen.

“Our base case is for credit spreads to reach historical lows in the first half of 2021 driven by low Treasury yields, improving technicals, and a yield grab environment resembling that following the financial crisis,” BMO’s high grade credit team went on to say this month.

Still, there are questions. And Deutsche Bank’s Aleksandar Kocic enumerated them in a recent note. “Questions like which businesses would survive the crisis, how many people will lose their jobs permanently, how will they pay their rent (and how will their landlords pay their liabilities), how much will they be willing to travel, consume, what services will they use, or how the banking sector will respond to all that, remain still largely out of grasp,” Kocic reminded folks earlier this month.

He also suggested that even after credit’s huge rally, it remained dislocated from equities, albeit with the correlation restored. That may point to more room for spread compression or it may point to a structural shift commensurate with the latent risks posed by a post-COVID reality that we can’t yet parse because we haven’t yet lived it.