Credit resilience but confusion surrounds longer-term inflation outlook

Key takeaways:

• 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.

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.

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.

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