We have seen considerable equity market volatility this year, with the US Federal Reserve Bank’s decision to taper its quantitative easing programme seemingly having consequences far and wide.
Fixed income – and more specifically global credit – has begun the year on a surer footing. Broadly speaking, 2014 is expected to be similar to 2013 from a corporate credit perspective, barring, of course, any unforeseen market dislocations.
Spread products, such as high-yield and leveraged loans, are expected to outperform investment grade and high-quality sovereigns, particularly if rates rise. They should continue to benefit from solid underlying credit fundamentals and a benign default environment.
It is anticipated that both US and European high-yield total returns are likely to be lower in 2014 compared with the previous year, albeit still outperforming other fixed income asset classes.
As far as the US is concerned, there could be increased market volatility around economic releases and Federal Reserve statements. This volatility can be viewed as an opportunity and some credit investors may benefit from more attractive entry points.
The Federal Reserve surprised many investors in the middle of December when it announced that it will reduce its asset purchase program and begin ‘tapering’ from January 2014. Further reductions will be in “measured steps”, provided that the US economy remains on track. As was already apparent in 2013, the multi-decade decline of US Treasury yields has most likely come to an end.
Looking ahead, corporate credit fundamentals remain strong in both the US and Europe. Refinancing risk remains low and balance sheets are solid. The low default rate of the past couple of years should continue and defaults in Europe and the US are expected to stay below 2 per cent.
Prices and coupons as of December 31 2013 imply a default rate of 4.3 per cent for the US high-yield market and 4.6 per cent for the European high-yield market. On an implied default rate basis, the high-yield market does not appear overvalued.
Whether high-yield inflows keep up with loan inflows will largely be a function of long-term government rates. If there is a repeat of May/June 2013 – Fed taper talk that led to a move in rates – we would expect loans to see inflows, while high yield might see outflows. Otherwise, in a benign rate environment, bond inflows are expected to exceed loan inflows. In short, flows into fixed versus floating spread products will largely be a function of rates. However, overall, spread products should see inflows.
George Muzinich is chairman, chief executive and founder of Muzinich & Co
