Janus Henderson Investors: Liquidity crisis begins to heal — Strategic Fixed Income view

Key takeaways:

• Given the size, scale and breadth of asset class purchases that central banks have embarked on, markets are beginning to heal. Last week, the investment grade market reopened in style with many high quality, multinational corporates issuing new bonds, with new issue premiums of typically 50 to 70 basis points.
• We are likely to see high default rates in sectors where there is very little equity value; zombie companies which have struggled in good times, such as energy, retail and some telecommunication companies in the US.
• Post crisis, prospects for government bonds seem binary; either a Japanese playbook of anaesthetising the bond market via yield curve control, or an inflationary boom driven by the coordinated fiscal and monetary response that has been unleashed.

It's March the 31st and following up from John [Pattullo]'s video last week, I wanted to provide a brief update for investors on what's been going on in credit markets and within our funds.

Liquidity crisis is beginning to heal

I think the first thing to note is that the liquidity crisis is beginning to heal. So central banks were three to five days behind the curve. They've adopted numerous programmes and the size and scale and breadth of the asset classes they're buying is encouraging; and the investment grade market has reopened in style. We've seen record issuance in US investment grade; bonds are coming to market very cheap, with new issue premiums of as much as 50 to 70 basis points. Allocations are low, demand is very high, and these bonds have been rallying as much as five points on the break.

So, the market is beginning to heal. We think quality investment grade credit, who have issued in the last week or so, works even in a recession/depression environment. These are quality multinational corporates with very little default risk. There is some downgrade risk, as with all corporates at the moment, but at spreads of 250 to 300 basis points over 10‑year government bonds, we find this a really compelling investment opportunity.

Tiptoeing back into risk assets

It must be remembered that corporate bonds rank senior to equity. So, if you wanted to dip your toe back into risk assets, quality investment grade bonds is obviously the first asset class to turn to and I think the decision by European regulators to suspend banking dividends (equity dividends) is interesting in that respect. AT1 coupons (subordinated bond coupons) are still intact, as we speak, and we expect rights issues or equity placings for equity investors who want to support quality companies to bridge any liquidity issues over the next six to nine months.

Default rates likely to be high in sectors that have struggled in good times

Sectors where there's very little equity value, which have struggled in good times, like energy, like retail and some telcos in the US, we expect very high default rates. We don't think equity investors or credit investors have the appetite to step into those sectors — those kind of zombie companies — but away from that in the high yield market, we are actually encouraged at the lengths that governments are going to, to try and prevent defaults, keep corporates in operation, and a good example of that is the German government supporting, KfW, the German industrial bank, lending to a company like TUI, the travel company, to keep it in business.

A very binary outcome for government bonds returns

So, we're very positive on investment grade credit. We selectively like areas of high yield market but it's going to wash around with equities and the economic impact of this virus. And on government bonds, there is really two scenarios here; there's either the Japanese playbook of anaesthetising the bond market via yield curve control and capping 10‑year bond yields at certain levels. That's US in the 1940s, Japan since 2016; and Australia last week went down that route for their 3‑year government bonds.

The other alternative, is an inflationary boom driven by the coordinated fiscal and monetary response that we've had, once we come out of this coronavirus. Simon Ward our monetarist economist is moving into that camp but really is two very binary outcomes of government bonds here. So we are less bullish government bonds than we have been, having been huge bulls for 10 years or so. We think investment grade credit is compelling at these kinds of spread levels and we expect risk assets to wash around with the news flow rate into the virus and the economic impact over the coming months. Thank you.

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