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February 2021 | Issue 231
Credit trends wider as it makes bad first compression in 2021
Dan Alderson
Deputy editor
With credit spreads starting the year close to the absolute tights they reached in early 2020, investor emphasis is heavily on relative value. But so far the most signposted of these trading strategies are failing to perform, while market-neutral opportunities have greatly diminished.
Beta compression topped the agenda for credit portfolio managers and strategists from the start of January, continuing a theme established in the last months of 2020. This was widely tipped to mean outperformance of high yield bonds and CDS over investment grade, as well as financial credits over non-financial and sub-financials over senior. Growth and inflation dynamics backed the view, along with pent-up demand from fund inflows and the roll out of covid-19 vaccination programmes.
But a month into the new year and there has been little to no traction with any part of the analysis. Credit has trended wider in a see-sawing motion and higher yielding assets have tended to underperform in each patch of weakness.
iTraxx Europe vs Crossover
Source: Citi Research, IHS Markit
“It’s a combination of factors,” says one New York-based portfolio manager. “High yield bonds have faced a heavy pipeline, but also negative convexity above par due to embedded call options. And in CDS there was a crowded long trade at the end of 2020, so you’re seeing some nervousness at these levels. Couple that with the realities of the covid situation and, particularly in Europe, the threat of borders closing.”
At time of press, the iTraxx Crossover and CDX HY indices were about 17bp wider apiece from the start of the year, at 260bp and 310bp, according to IHS Markit. This was against 2bp and 3bp moves in investment grade indices iTraxx Europe and CDX IG, at 50bp and 53bp respectively. The Senior Financials basket of Europe was similarly about 2bp wider at 60.1bp.
Trading so far has also thwarted notions there might be compression between European and US credit. Giving weight to this view had been the weakness of the US dollar and hopes of a big round of stimulus under president Joe Biden’s administration.
In a January research piece, Bank of America strategists said they preferred cash bonds over CDS at current valuations in the US and Europe, arguing high yield bonds looked cheap versus synthetics.
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Global credit funds & CLO's
February 2021
| Issue 231
Published in London & New York.
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