Alternative Credit Letter

Year to date, the US leveraged debt market posted strong performance, with returns of 8.3% in the leveraged loan (syndicated bank loans) segment and 8.7% in high yield bonds. In contrast to previous years, the

Leveraged loans delivered one of the strongest gains of the year during October, outperforming the high yield market by 1.45%. The month was marked by heavy CLO issuance, robust primary market activity, and substantial fund

U.S. homeowners’ equity has reached a historic high, with $ 35 trilion, serving as a substantial financial backstop for the economy in the event of a recession. In such a scenario, homeowners have the option

Historically, bank spreads have typically traded wider than those in the broader corporate market. However, this gap has almost disappeared, driven by the positive dynamics and performance within the banking sector since the European Central

The global economy has to deal with higher structural inflation forces driven by aspects such as geopolitics (i.e. new tariffs, near-/on-shoring), energy transition, demographics or elevated fiscal spending. However, over the next 12 months, the

US High Yield corporates are delivering solid results following a first quarter of earnings beats and generally positive guidance. Although leverage ratios have seen a minor increase of 0.05x in 2024, leverage ratios remain well

The remaining maturities for high yield bonds and leveraged loans for 2024 account for only around 1% of the total market. The significant volume of bond refinancings in 2024 and 2023 after a year of

The syndicated loan market shows better credit metrics as compared to 2022 when interest rates started to spike. In the interim, some of the weakest companies suffered a default or went through a restructuring, but

In the past two years, net issuance of high-yield bonds has declined significantly. A sharp rise in the cost of capital coupled with a phase of enormously increased new issues in 2020 and 2021 led

There is significant dispersion in the European High Yield market indicating an increasing divergence between BB/B and CCC rated credits. Unlike in the European market, this divergence did not occur in the same magnitude in

The performance of local emerging market debt portfolios has historically been relatively closely negatively correlated with changes in the US 10-year treasury yield. For example, the drop in US 10-year yield during 2020 COVID pandemic

Following the rally on credit markets during Q4 2023, more than a third of US High Yield keeps trading at credit spreads below 200bps over risk-free rates. On a risk-adjusted basis, such spreads remain tight

Current market yields continue providing an attractive entry point across sectors in context with their historic downside risk, calculated as standard deviation of negative monthly returns over the last 10 years. This includes particularly adverse

Historically, the income and total returns on European broadly syndicated loans have been comfortably exceeding realized default losses. This trend is evident from the chart with incomes, comprising of interest and fees, exceeding 4% and

The yield breakevens, calculated as yield divided by duration, indicate by how much can yields rise, or credit spreads widen, before incurring capital loss equal to annual yield accrued on investors’ holding. A ratio of

Following further slowdown in inflation expectations, real rates have surged in the last three months and are now exceeding 2%. The positive long- and short-term real rates benefit fixed income investors across entire spectrum of

While increasing risk free rates have been the key drivers of rising yields and returns of syndicated loans during the last twelve months, the credit spreads, represented as discount margins over floating benchmark rate, have

Yields on first lien private loans have reached their highest levels since 2008 during the Great Financial Crisis and remain attractive relative to broader private loan market as well. For illustration, first lien yields on

Following interest rate hikes and considering growing evidence that inflation expectations had peaked, the short-term real rates have been recovering from their record lows. At the same time, the 5-year breakeven inflation data suggest stabilization

Since the start of the FED’s tightening, credit spreads on residential mortgage-backed securities (MBS) have been widening significantly. For example, the credit spreads on junior B1 and B2 tranches of Credit Risk Transfer notes (CRT)

Yields on leveraged loans are currently reaching 10% and remain materially higher than yields on equities. Since 2022 the loan investors have been benefiting from rising rates, which translated into increasing income via quarterly benchmark

Credit yields are now significantly higher than earnings yields on equities. HY bonds are currently yielding 8.5% and loans 10.4%. Meanwhile, earnings yield on equities ranges from 5.1% current to 7.5% when adjusted for the

One of the fastest rate increase paths in modern history has led to a true paradigm shift in US Treasury rates. Compared to one year ago, the rate levels are now higher and have negative

Central banks moved away from easy money policies and changed course. Not only the interest rate hikes but also the liquidity withdrawals have affected the markets and will continue to do so. After years of

Slowing global economy, combined with tightening financing conditions and input costs inflation will lead to higher expected credit default rates in 2023 and beyond. In our observations, market participants expect that defaults would peak at

Since the start of the year, credit spreads of European loans have increased from around 400 bps to above 700 bps. At the same time, short-term interest rates have just been lifted to around 2%

The Fed’s rate hike path in 2022 is driving up bond yields in all markets. For example, the yields of the short-term high yield and investment grade bond indices bottomed out in 2021 and climbed

In March 2022, the USD swap curve became inverted and by the end of August the difference between the 2-year vs 10-year tenors fell to -0.6% (see also Alternative Credit Letter in April), a signal

The peak Fed funds rate is currently priced in at a level of 3.4% (down from >4% in mid-June) for February 2023. However, the shape of the curve is of even greater importance. The inverse

Fixed income markets suffered in June another painful month. For example, high yield bonds are down -7.3% and -16.7% YTD, the worst half-year performance since the global financial crisis in 2008. The sell-off this year

The Bloomberg Global Agg. Bond index, which is composed of corporate and government bonds, experienced with a decline of -11.6% year-to-date by far the worst performance on record! The losing run came only to a

Yields of US short term low grade bonds broke through the 10-years average of 5.7% and reached a level of 6.9%. Since the Fed signalled a faster pace of interest rate increases in the coming

In macro-finance, it is well known that an inverted yield curve is signaling a recession or at the very minimum, it is indicating that the economy is operating in a late cycle. For example, the

Within a matter of only two weeks, European High Yield spreads have jumped to a spread level of 480 bps, well above the last 5 years average of 366 bps and back at August 2020

Looking back at the last rate hike cycle (2015-2018), credit spreads for both high yield and investment grade bonds were not immediately negatively affected when the Fed rates started to take off. However, the more

Investors have somehow learnt to deal with low or negative nominal yields. But now, as real yields fell to record low levels such as -6.8% in the example for short-term real rates, bond investors need

The hawkish tone of Powell’s remarks on November 30 surprised the market and the yield curve flattened significantly as a consequence. While long term rates retreated considerably, the Fed funds futures imply a sooner Fed

Since the beginning of 2021, breakeven inflation has risen sharply, and has reached almost 3% at the end of October, leading to a breakout in short term nominal yields and a bear flattening of the

Leveraged loans held steady during the risk-off mode in the 2nd half of September. While US high yield bonds were negatively affected by higher trending interest rates and falling equity markets, leveraged loans benefitted from

While high quality bonds with close to zero yields haven’t offered a feasible investment opportunity since a long time, equities rallied over the last 18 months. However, equities trade now at elevated levels in a

The Treasury yields fell substantially in July, especially at the long end of the curve. Moreover, current Fed fund future prices point to a more moderate pace of rate hikes, as the chart illustrates. It

CLOs have always offered an attractive premium to bond or loan spreads, but investors continue to overlook the asset class due to their complexity and as they tend to be less liquid during market stress

The steepening of the US Treasury bond yield curve increased the volatility of interest rates overall. This is well illustrated by the MOVE index, an indicator that measures interest rate volatility using the implied volatility

In 2020, the rating agencies acted as quickly as never before in downgrading the issuer ratings due to the COVID-19 pandemic – very different to 2007/08, when rating agencies were criticized for acting too slowly.

In anticipation of a strong economic recovery ahead of us, long term interest rates have spiked from their historical lowest levels This has paid its toll For example, US investment grade bonds suffered a performance

Since December 2020 US long term nominal yields (US Treasury 10y) rose 60 bps, while expected inflation (US Inflation Swap 5y5y) remained flat at ~2.2% Markets incorporate a benign outlook, but inflation will pick up significantly over

Since September 2020, the FED’s policy allows for a period of inflation over their 2% target: “[…]the Committee will aim to achieve inflation moderately above 2 percent for some time[…]”, which is indicating that they

With the arrival of the pandemic crisis, the FED had cut rates aggressively close to zero. In addition, it had announced an adaption of its interest rate policy towards an “average inflation targeting” and that it will keep

During the market rally in November, credit spreads have further tightened and reached almost pre-Covid levels in the investment-grade category, whereas spread levels are still wider in the high-yield market. OAS of broad US investment-grade

Year-to-date US high yield corporate rating downgrades accumulated to more than 475 – even surpassing the previous crisis in 2008. The up-/downgrade ratio (proportion of upgrades among total rating actions of Moody’s and S&P) marked