Skip navigation Scroll to top
Scroll to top

With central banks moving to tighten policy further, how will that impact the credit market?

26 November 2021

Over the past year, the market narrative has increasingly focused on inflation. Whilst “transitory” has very much remained part of central bank vernacular, the longevity of supply chain pressures, paired with relatively healthy household savings, has raised concerns that elevated inflation expectations could change consumer behaviour.

inflation money currency 1200x750

Jeremy Sterngold – Head of Fixed Income

Over the past year, the market narrative has increasingly focused on inflation. Whilst “transitory” has very much remained part of central bank vernacular, the longevity of supply chain pressures, paired with relatively healthy household savings, has raised concerns that elevated inflation expectations could change consumer behaviour. With this in mind, central banks are looking to pare back their accommodative stance at a faster pace than envisaged only several months ago. Even though the US Federal Reserve (Fed) announced a $15bn a month tapering program at the start of November, the minutes of the meeting that were released this week showed a desire to increase the pace if inflation remains elevated or more people re-join the labour force. In addition, both the Bank of Korea and Reserve Bank of New Zealand increased base rates this week for a second time by 0.25%.

As interest rates rise more swiftly and further asset purchases decline, this has moved shorter dated bond yields higher injecting a higher degree of volatility in government bonds. We have previously talked about how to navigate this environment for government bonds; (Can you make money in bonds when the bank is expected to tighten?), but how does this affect corporate and other riskier bonds?

Corporate debt received a lot of support from central banks at the onset of the pandemic, with the Fed adopting an investment grade corporate bond purchase program for the first time in its history. The European Central Bank and Bank of England also intervened to help companies retain access to affordable financing when the world locked down. Such a strong injection of liquidity combined with a swift recovery drove credit spreads sharply lower, touching their lowest levels since 2007 over the summer. This makes a lot of sense given that earnings rebounded strongly and as such companies were better able to service their debt. So far, inflation has not affected company margins in a major way and therefore nominal debt is inflated away to some degree. This year, we have seen minimal defaults in the High Yield (HY) market and a large amount of companies seeing their credit ratings upgraded. The exception to this is Asian HY which has seen Chinese property developers moving towards defaulting on some of their debt.

With valuations not particularly attractive in the market at a time when corporate earnings could be squeezed by rising input costs and central banks pairing back their accommodative policy stance, this does not sound like the backdrop where you want to aggressively be buying credit. Hence, I would expect corporate bond compensation to rise moderately from here over the next few quarters. However, if this is paired with rising government bond yields and overall healthy corporate balance sheets, the rise in overall yields will bring buyers back to this market.

In summary, the next few quarters may prove to be challenging for buy to hold investors; however, if you are nimble then you may get opportunities to buy corporate bonds at better compensation levels. As such, we tend to avoid managers or tracker funds that hug a benchmark closely and prefer to invest in ones that can adapt quickly to new investment environments.

Read more from The Brief.

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom.