John Pattullo, Co-Fund Manager of Henderson Diversified Income Trust, explains how the suppression of volatility by the US Federal Reserve during the Covid crisis has led to the Japanification of the US corporate bond market.

 Key takeaways:

  • Just as we saw in Europe, Japanification — which refers to Japan’s experience of persistently low interest rates, low inflation and low growth and where the central bank has completely supressed volatility — has now spread to the US and, at a remarkably faster pace.
  • As was the case in Japan, the US central bank’s suppression of volatility, together with its backstopping of investment grade (and, to a lesser extent, high yield) bonds, has created an almost idyllic environment to invest in corporate bonds.
  • With the collapse of the sovereign yield curve in the US, there have been large inflows into the US corporate bond markets in recent months, with overseas buyers as the major participants. Interestingly, given the unending search for yield, quality, well‑known investment grade names are now almost the new sovereign bonds or the new benchmark rates.

Note: this video was recorded on 14 August 2020.

 

Glossary

Bond: A debt security issued by a company or a government, used as a way of raising money. Bonds offer a return to investors in the form of fixed periodic payments, and the eventual return at maturity of the original money invested

Commodity: A physical good such as oil, gold or wheat. The sale and purchase of commodities in financial markets is usually carried out through futures contracts.

Corporate bond: A bond issued by a company

Cyclical: Companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as miners. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclical companies.

Default risk: the risk that a lender takes on in the chance that a borrower will be unable to make the required payments on their debt obligation.

Hedging: taking an offsetting position in a related security, allowing risk to be managed. These positions are used to limit or offset the probability of overall loss in a portfolio. Various techniques may be used, including derivatives.

Inflation: The rate at which the prices of goods and services are rising in an economy. The CPI and RPI are two common measures. The opposite of deflation.

Investment grade bond: A bond typically issued by governments or companies perceived to have a relatively low risk of defaulting on their payments. The higher quality of these bonds is reflected in their higher credit ratings when compared with bonds thought to have a higher risk of default, such as high-yield bonds.

Sovereign bond: Bonds issued by governments and can be either local-currency-denominated or denominated in a foreign currency. Sovereign debt can also refer to the total of a country's government debt.

Systematic rick: “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry

Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment

Yield: The level of income on a security, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.