Jenna Barnard, Co-Head of Strategic Fixed Income, shares the Strategic Fixed Income Team’s current thoughts and views on bond markets, and addresses the most frequently asked question: is inflation on the rise?
Credit spreads have held up remarkably well despite a tsunami of issuance since mid‑March, including record breaking volumes of new investment grade issues (over a trillion US dollars so far).
With total issuance generally expected at around US$1.5 trillion for this year, the pace is set to naturally slow from now on.
Is inflation about to take off? We caution against misinterpreting price volatility as an inflation cycle about to erupt.
Note: this video was recorded on Monday 18 May 2020.
Credit holding up well despite a tsunami of issuance
This is a brief weekly video update from John and myself.
If we start with credit, I would say credit spreads have actually held up remarkably well in the face of really a tsunami of issuance — record breaking investment grade issuance — and pretty healthy high yield issuance as well. That's been going on now since mid-March when the market reopened. And as I said, credit spreads have absorbed that supply, with only very modest widening from the April tights.
That now looks to have peaked. We think last Monday [11 May] was the peak in investment grade supply, and we think it could actually taper off pretty quickly. May was always due to be a very high month of issuance seasonally. We’re pushing a trillion dollars of investment grade issuance. Most estimates are about one and a half trillion through to year end, and the pace will naturally slow. You know most companies have raised a war chest of liquidity to get them through even potentially a second wave of this virus in the autumn. So that's probably the only meaningful news in credit markets.
A general confusion: inflation is about to take off
And then if we turn to government bonds and duration, I think the primary question that John and I keep receiving is ‘what about inflation?’ What about inflation? Is it about to take off? And the one thing we would caution here is, to not confuse price volatility coming out of a crisis like this, with inflation and an inflation cycle, which requires a mechanism to be self-sustaining. Prices go up, wages go up, prices go up again. If we remember coming out of the 08‑09 crisis, the UK did record CPI* headline inflation of over five percent, in late 2010 and into 2011. That was a function of base effects — the very low inflation readings the year before — commodities bouncing, and some currency depreciation also feeding through. The Bank of England did not hike in response to that CPI* print of over five percent and ultimately inflation petered out and we ended up with a very low print the next year.
So, price volatility, yes; we can see price volatility after a crisis like this, and very weak inflation readings this year, but an inflation cycle — no; we're not in that camp whatsoever. And I'd caution against this obsession with inflation distracting investors [from] the big issue or the big challenge of the next five or ten years, which is a lack of income. Interest rates are [likely to be] on hold for years and central banks have been very clear about that; one high inflation print does not make up for a decade of undershooting inflation before this deflationary crash we're in at the moment.
Good reasons to remain positive on credit
So, credit. We think… we're actually quite positive given the new issuance peak, and government bonds are washing around in quite a kind of low yield range, and we caution investors about confusing price volatility with a real inflation cycle. We think the primary need in the next five to ten years is going to be a reasonable, sensible, income that you can trust – and that, we think, you get from select corporate bond investing. And with that, thank you and good luck out there.
*CPI: consumer price index
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A.
An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
When the Fund, or a currency hedged share class of the Fund (with ‘Hedged’ in its name), seeks to mitigate (hedge) exchange rate movements of a currency relative to the Fund’s base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
Some or all of the Annual Management Charge and other costs of the Fund may be taken from capital, which may erode capital or reduce potential for capital growth.
The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.