Rallying bond yields supported fixed-coupon markets, particularly in the US, which now look particularly expensive.
Against a backdrop of rallying sovereign bond markets, credit markets across the asset-class spectrum posted gains. The top performers were asset classes that pay fixed coupons; these benefited from the fall in risk-free rates, particularly in the US – where investment-grade and high-yield bond markets both delivered solid returns. Ninety One’s Multi Asset Credit team reflects on Q3 in its latest Credit Chronicle.
Investment-grade (IG) markets achieved some of the strongest total returns among credit asset classes in Q3, driven almost entirely by significant falls in risk-free yields, particularly in the US, as the Fed’s first rate cut led to strong demand for high-quality credit. This was clearly reflected in the US IG market, which posted a 5.7% total return over Q3, despite IG spreads being effectively unchanged through that period. The high-yield market was also buoyant in Q3, as noted below.
Darpan Harar, Multi Asset Credit Portfolio Manager, Ninety One says: “In traditional markets, such as US high-yield debt and US investment grade, credit spreads remain near the tightest levels seen over previous cycles; we see limited potential here for further price appreciation or attractive income. In contrast, higher carry (higher income) holdings such as structured credit, loans, and selective parts of the short-duration high-yield and bank capital market, offer an attractive income profile and favourable downside characteristics.”
Also read: A Divided Government May Have Positive Impact On Long Term Treasury Yields
Leverage loan markets delivered another strong quarter of steady performance, with September the 11th consecutive month of gains. US and European loans returned a solid 2.0% and 1.9% respectively over the quarter. CCC rated loans notably outperformed other rating segments; this reflects the prospect of rate cutting cycles providing respite for those loan issuers with the most stressed balance sheets. The strong technical (supply/demand) backdrop has remained supportive of loan market returns. Despite persistent modest outflows from loan funds throughout much of the quarter, CLO formation – which is the dominant driver of demand in the loan market – has remained robust; year-to-date US CLO formation of US$141 billion is near record levels, lagging only the record year of 2021. This solid demand backdrop for loans has facilitated strong year-to-date new issue volumes, even if this has been dominated by refinances/reprices, with limited new money issuance until more recently. New money supply did, however, meaningfully spike in September, the busiest month since early 2022, with almost half of US total loan supply consisting of either M&A or dividend recapitalisations.
Loan market performance was overshadowed by the 5.3% and 4.0% seen in US and European high-yield markets, which were boosted by the rally in sovereign bond yields.
However, Harar notes: “Tighter spreads and lower yields are starting to drive behavioural changes among high yield debt issuers – reflected in a significant amount of debt-funded dividend recapitalisation on both sides of the Atlantic. Similarly, deals which would fall under private credit markets 12 months ago are increasingly being handed to the broader syndicated market instead. We note that Q3 European high-yield issuance was EUR26 billion, and single-B rated issuers have constituted one-third of all issuances. We see this increase in supply as the first signs that technicals (supply/demand dynamics), which have been extremely favourable in the past 12 months, are likely to become slightly more challenged as we move into the new year.”
