The record breakers
Levels of US corporate debt issuance smashed expectations in 2020 say Mellon head of index Stephanie Hill and senior investment strategist Theodore Bair. Here, they reflect on some dramatic market moves and factors likely to influence its future direction.
Record issuance was the name of the game for US corporate debt in 2020 as the Covid-19 pandemic ravaged the world’s economy. That’s according to Mellon head of index Stephanie Hill and Theodore Bair, senior investment strategist, as they look back on what was an extraordinary year in the fixed income space.
For Hill, it was a year characterised by abrupt turnarounds and dislocations, beginning with intense market disruption in late March – with companies seeking liquidity at all costs – to opportunistic refinancing and the beginnings of a recovery towards the end of 2020. The overall result, she says, is an issuance landscape “redrawn almost beyond recognition”.
For Bair, the contrast with the beginning of the 12 months is a telling one. “At the start of the year,” he says, “the picture was very different”. At that point, on the threshold of a new decade, sentiment in the US credit markets remained remarkably sanguine. “Several quarters of robust corporate profitability provided support for relatively strong interest coverage ratios despite a minor uptick in net leverage,” he says. “Credit spreads over the course of 2019 were range-bound, ending the year slightly tighter at 90 basis points as measured by the option-adjusted spread (OAS) of the Bloomberg Barclays US Credit Index.”
Even as reports of a new virus in Asia began to filter through, spreads barely widened – and it was only when the virus spread to Europe, the US, and then on to the rest of the world that investors began to struggle with increasing levels of uncertainty. On 11 March, 2020, the World Health Organization (WHO) declared the coronavirus outbreak a global pandemic. The following day, a US equity sell-off triggered a market-wide circuit breaker event, the first of several over the coming days and weeks. On 13 March, the United States declared a national emergency regarding the coronavirus outbreak.
The result, says Hill, was a dramatic widening of US credit market spreads, with a 341-basis-point high reached in late March due to intense selling pressure. Against this backdrop, she says, primary market activity ground to a halt while secondary market liquidity dropped precipitously, and bond bid-ask spreads nearly tripled. “Faced with rapidly worsening market sentiment, corporate issuers adopted a ‘survive-at-any-cost’ approach and swiftly tapped any and all available revolving bank credit facilities in an effort to shore up their balance sheet liquidity,” she continues.
Central bank support
It was at this point that central banks stepped in. Bair highlights how, leading a globally co-ordinated response, the US Federal Reserve slashed benchmark interest rates twice in early March (for a total of 150 basis points) and once more began its purchases of US Treasuries and mortgage-backed securities in an attempt to restore market functionality. At the same time, it addressed the short-term borrowing needs of corporations by restarting two Global Financial Crisis-era programs focused on supporting money market funds and direct issuers of commercial paper. Other major developed economies such as the European Union, the UK and Japan took a similar tack, restarting or increasing existing quantitative easing programs focusing on government debt.
However, the crucial cornerstone of the Federal Reserve’s (Fed) efforts came on 23 March, when the Fed launched two new programmes aimed squarely at the US corporate markets. “Eventually totalling US$750bn in authorized capacity, these programs allowed the Fed to lend directly to corporations though the Primary Market Corporate Credit Facility; or to purchase existing bonds or ETFs focused on corporate bonds through the Secondary Market Corporate Credit Facility,” concludes Hill. “In response, spreads declined rapidly after 23 March as the market digested news that the Fed and other central banks around the world were taking aggressive actions to stabilize the markets.”
Where Do We Go From Here?
As we look ahead to the remainder of 2021, both Hill and Bair believe there are several key themes relevant to the direction of US credit markets in the months to come:
- How will the election of Joe Biden to the US presidency impact issuance in the months ahead? Arguably some of the issuance that occurred in September, coupled with a relatively brisk October calendar, reflected issuer’s desires to lock in funding or take advantage of historically low coupon rates ahead of a contentious and volatile election.
- In a world where there are virtually no remaining safe harbours offering a measurable yield, will investors continue to turn to credit as a means to satisfy their hunt for yield? According to recent research from JP Morgan, 70% of the stock of global sovereign debt carries a negative real yield. With central bankers adopting a ‘lower for longer’ mantra, investor appetite for US credit is likely to remain strong in the near-term.
- While US corporations have issued record-breaking levels of new debt this year, what will they do with this cash? While certain sectors will rely on their cash buffers to survive the pandemic (airlines, hotels, retailers, restaurants, etc.), other issuers (technology, pharmaceuticals, financials) seem likely to emerge from the pandemic relatively unscathed. Will this set of survivors pay back debt, reinvest in their businesses or go on buying sprees?