Skip to content

Blog

Three Risks to Credit Markets This Summer

Kenneth A. Orchard, Portfolio Manager, Global Multi-Sector Bond and Diversified Income Bond Strategy

Why I’m becoming more cautious on corporate debt.

After a very difficult few months, the credit market is looking strong again. Central bank bond buying has made investors long cash, there have been strong inflows into the market, and spreads have retraced about three‑quarters of the widening in the first quarter. Our macro market and sentiment indicators are still suggesting that being long credit risk in our portfolios could be the correct approach. However, there are three potential sources of upcoming uncertainty that pose a risk to this picture: a second wave of the coronavirus, a worsening economic outlook, and market volatility ahead of November’s U.S. presidential election. Let’s look at each of these in turn.

Opening Quote I think a second wave of the coronavirus looks unlikely in the near term. Closing Quote

I think a second wave of the coronavirus looks unlikely in the near term. There has generally been a minimal increase in virus transmission rates in places where the lockdown has been eased and it seems that progress is being made on developing vaccines. This does not mean that there won’t be a second wave at some point, but it does not look like it will happen this summer. It may be a risk for the autumn.

The economic outlook is harder to call. It was predictable that there would be a massive decline in economic activity as lockdowns were put in place across the world, followed by a resurgence in activity once those lockdowns were lifted. More difficult to predict is the rate of growth after all the offices, shops, and restaurants are open again. Activity won’t return to its previous peak immediately; I believe it will quickly rebound to some point below the peak before climbing at a slower pace after that. The inflection point and pace of that second phase of the recovery will impact corporate profitability, unemployment, fiscal stimulus programs, and monetary policy in the fourth quarter and in 2021. Hence, there is significant uncertainty about what those will look like.

Ahead of the U.S. election, presumptive Democratic presidential candidate Joe Biden is comfortably ahead in the polls. How will his rival Donald Trump react if that does not change? It’s difficult to say, but he probably won’t go quietly. As the election looms, policy surprises and rising geopolitical tensions are very possible as Trump seeks to reinvigorate his voter base. And if Biden maintains his poll lead, markets will begin to weigh up the likely impact of a Democrat victory on the economy. Either way, the lead‑up to November’s election is likely to bring uncertainty for financial markets.

Opening Quote ...policy surprises and rising geopolitical tensions are very possible as Trump seeks to reinvigorate his voter base. Closing Quote

So, of the three potential sources of uncertainty I’ve highlighted, I think one is low risk, one is moderate risk, and one is high risk. Cheap valuations can act as a buffer to uncertainty and, until recently, spreads were pricing in a lot of bad news, including the recession. However, spreads have tightened a lot since late April, so that buffer is no longer there. Spreads may need to widen again as economic and political uncertainty rises.

In the early days of the coronavirus, negative sentiment also provided a buffer to uncertainty (downside surprises are less damaging when everybody already expects the worst). But as economic data improve and optimism about the post‑coronavirus future builds, the risk of disappointment will increase. What’s more, very high rates of corporate bond issuance are causing the market to gradually adopt longer credit risk positions as it absorbs the new debt. That will further reduce the buffer to uncertainty as investors will not have room to add on any sell‑offs.

This combination of rising uncertainty and less protection against that uncertainty means that credit markets are likely to become more volatile in the summertime, in my view. This does not mean I’m bearish on credit (I’m not yet), but it does mean that I’ve become a little more cautious.


Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

© 2020 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.

202006-1217966

Download

Audience for the document: Share Class: Language of the document:
Download Cancel

Download

Share Class: Language of the document:
Download Cancel
Sign in to manage subscriptions for products, insights and email updates.
Once registered, you'll be able to start subscribing.

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the twenty four-year period ended June 30, 2020, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest