Fixed Income

Three Credit Investment Ideas to Consider if Reflation Occurs

November 20, 2019
Loans, unloved corporates, and hard currency EM debt look tempting.

Key Points

  • Stabilizing economic data are likely to throw up some compelling opportunities within the fixed income sector.
  • The floating rate bank loan market stands out as, potentially, the most interesting credit allocation.
  • Opportunities are also likely to arise in specific corporate bond sectors, while hard currency emerging market bonds appear to be positioned to perform.

Recent economic data have been encouraging in the U.S., Asia, and, to some extent, Europe, which could be a sign that economic conditions have begun to stabilize. However, it is still too early to determine whether this represents merely a pause in the slowdown or the beginning of a late‑cycle rebound. In our latest policy week meetings, the investment team discussed the potential impact of the improving data on fixed income markets, focusing in particular, on which parts of the credit market could benefit the most if the “reflation trade” story continues to gain traction. Below, Saurabh Sud, portfolio manager and member of the global fixed income investment team, highlights three credit investments to consider in a reflation scenario.

1. The floating rate bank loan market is attractive again.

The loan market has underperformed high yield over the past nine months as the market has priced in more rate cuts by the Fed, leading to significant outflows. Negative headlines have also hindered the asset class—particularly as the pace of rating downgrades has increased lately—and its impact on bank loan demand by collateralized loan obligations (CLOs). A more favorable economic environment would offer some respite for loans, which currently offer attractive valuations compared with conventional high yield. Demand could pick up at a time when the Fed is expected to remain on hold and there is strong interest in cash‑related products. Overall, this looks like it may be a good entry point to allocate back to floating rate loans.

But not all parts of the loan markets are attractive: B issues launched in 2017–2019, for example, are expected to have a high risk of default and could see widening spreads even if the rest of the loan market performs well. Security selection remains key in this very technical asset class. In particular, research team members highlighted discount loans with strong asset coverage and high visibility on the company’s ability to pay down or refinance the loans in the next two to three years.

Overall, this looks like it may be a good entry point to allocate back to floating rate loans.

2. Unloved parts of the corporate bond market are worth a look.

Within investment‑grade corporate bonds, the energy sector has suffered from low oil prices for a while now and would benefit from a reflation environment. If growth picks up in the U.S., energy names, either pipeline, or extraction‑related, may offer value. The most interesting names are probably to be found in higher‑rated high yield issuers, but distressed debt should continue to be avoided as the team still expects defaults to hit the sector as capital continues to recede from unsustainable business models and capital structures. Now may also be a good time to focus on the automobile sector, which has lagged the rest of the credit universe over the past two years amid low demand, a correction in valuations, and concerns over vehicles’ environmental impact. It may be time to consider reallocation, particularly to short‑dated bonds, where the valuation correction seems to have been overdone. Apart from certain companies such as Ford, the market is no longer expected to suffer downgrades, and a resurgence of consumer demand would boost the economic profile of these companies.

If growth picks up in the U.S., energy names, either pipeline, or extraction‑related, may offer value.

3. Emerging market hard currency bonds offer value.

Stabilizing growth and lower geopolitical risk may also prove to be positive for hard currency bond‑issuing companies domiciled in emerging market countries, particularly Asian credit securities. A stronger outlook for global demand, improving U.S.‑China trade relations, and a weakening U.S. dollar will make it easier for these companies to borrow in U.S. dollar terms and improve their ability to repay. In addition, investors allocating to EM companies now have the opportunity to capture income from companies that are for the most part investment grade‑related, offering some protection should the reflation story not play out as expected.

The same can be said for hard currency sovereign bonds, where demand has started to increase. However, the higher duration profile of hard currency bonds could make them more vulnerable to a rise in interest rates, so our preference would be for shorter‑dated bonds.

Global Fixed Income Team

The committee comprises some of our firm’s most senior investment professionals:

  • Arif Husain, CFA
  • Andrew Keirle
  • Kenneth Orchard, CFA
  • Quentin Fitzsimmons
  • Ju Yen Tan
  • Saurabh Sud, CFA

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Important Information

Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets.

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of November 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.


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