Glimmer of hope for US credit markets?

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Investing in the US - January 2016

US fixed income struggled in 2015 and the outlook for this year remains uncertain given the potential for further US interest rate hikes and global growth concerns, especially in China.

In terms of performance last year, US Treasuries lagged their European and Japanese peers, according to data from S&P Dow Jones Indices. Figures show the S&P BGCantor US Treasury Bond index delivered a total rate of return (in local currency terms) of just 0.8 per cent in 2015.

The S&P UK Gilt Bond index was slightly lower at 0.7 per cent, but the S&P Japan Sovereign Bond and S&P Eurozone Sovereign Bond indices were roughly double the return of the US at 1.6 per cent each.

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Kevin Horan, director of fixed income indices at S&P Dow Jones Indices, explains: “Sovereign yields reached all-time lows globally in 2015 as the difference between the highest yearly yield-to-worst in the UK at 1.95 per cent and the lowest yearly yield-to-worst of Japan at 0.21 per cent was only 174 basis points [bps].

“The US Federal Reserve’s December rate hike of 25 bps had very little impact on the broader US index as the yield-to-worst for December 31 was 2 bps lower than the December 16 yield of 1.49 per cent. The market’s expectations for rates to remain low in 2016 appear to be reasonable as Europe and Japan continue to look to stimulate growth in their local economies.”

But he notes that the 2015 total rate-of-return performance of the four countries pales in comparison with the returns achieved in 2014, with the 2015 US return of 0.8 per cent significantly lower than the 3.7 per cent achieved in the previous year.

Looking across the fixed income spectrum, data from FE Analytics comparing the Barclays US Government, US Corporate Investment Grade and US Corporate High Yield indices shows that in spite of the lower returns, government bonds have performed slightly better.

The US government index delivered a total return of 6.7 per cent in 2015, compared with 5.1 per cent from investment grade and 1.1 per cent in high yield.

M&G head of retail fixed interest Jim Leaviss emphasises there is little relative value in US government bonds given the likelihood of further interest rate rises in the year ahead, and instead points to “attractive opportunities” in certain segments of the US corporate bond markets.

Mr Leaviss comments: “There are two significant supports in place for credit markets as we go into 2016. Credit spreads in both investment-grade corporate bonds and high yield are likely to overcompensate for expected default rates. [Also,] in a world of low or negative yields in government bonds, investor demand for credit remains firm.

“US investment grade underperformed in 2015 due to the weight of issuance there as companies anticipated the start of the Federal Reserve’s hiking cycle. As a result, the pick-up in yield over European investment-grade debt is now more than 2 per cent at the index level.

“While there is a perception that credit is expensive, it is worth noting that in the past 20 or so years global corporate bond spreads have been tighter than they are now around 73 per cent of the time.”