Market Perspectives

Fed Ammunition / Re-looking
the US Investment Grade Opportunity

24 September, 2020

The Big Picture: Matching willpower with firepower

A current look-in at the amount designated, allowed, and spent by the key US authorities combating the economic and financial fallout of COVID-19, paints interesting observations.

Of the total USD 11.6 Trillion set aside, about 43% has been committed or disbursed. That leaves under 57% of intended support left untouched, a seemingly healthy buffer. 

Chart 1: An updated view of pledged and utilized government support (USD Trillion)

Chart 1 source: Committee for a Responsible Federal Budget. Data as of 21 September 2020. 

A deeper dive, however, reveals that the Fed’s initial direct asset support that played a key role in stabilizing asset prices since market lows in late-March 2020, is close to being exhausted. That said, the Fed still has over USD 737 billion in dry powder in its Corporate Credit Facilities magazine. 

Chart 2: Original bonds support has dried up, but a large cushion remains (USD Billion)

Chart 2 source: Committee for a Responsible Federal Budget. Data as of 21 September 2020. 

In addition, much has been set aside…still mostly unused to combat any surge in illiquidity. 
Chart 3: The liquidity war chest is barely touched (USD Trillion)

Chart 3 source: Committee for a Responsible Federal Budget. Data as of 21 September 2020. 

The vast amount of resources is enabling the Fed to keep stimulating the economy in hopes to produce inflation past 2% and that implies lower rates for a longer period. There is no doubt that the Fed has brought back some confidence that was badly drained towards the end of Q1 2020. 

Zeroing in: Re-examining US Investment Grade 

Within US bonds, there is perhaps no other area where market confidence is clear. US Investment Grade bonds were designated as early recipients of Government support and the asset class found its feet quickly rising 6.7% year to date as of the end of August 2020*. What was supposed to be a dismal year for corporates got a shot in the arm. Most were winners except sectors hit hard by COVID-19, Leisure and Airlines. 

Chart 4: Gains were (mostly) across the board (%)

Chart 4 source: Bloomberg, *Bloomberg Barclays US Credit Total Return Value Unhedged. Returns in USD. Data as of 31 August 2020.

Against the background of such sizable gains, investors have begun to ask if the US investment Grade asset class is overbought. Valuations are less attractive than in the recent past as spreads have meaningfully recovered from crisis levels. In addition, the weight of a spreading virus, a weak global economy, and an upcoming US general election could produce volatility ahead.

However, the technical backdrop remains positive with the pace of new-issue supply in the second half of the year expected to decelerate as most firms have already liquefied their balance sheets. That said, the low-yield environment is incentivizing borrowers to conduct liability management exercises whereby they issuer longer-dated debt to tender for high-coupon shorter maturity issues. Against that, demand is expected to remain robust.

The bottom line

Credit fundamentals will undoubtedly be challenged as we head into the fourth quarter of this year. However, the US Investment Grade asset class has historically provided investors with stable income amid lower default risks and is thus an important component of a well-diversified portfolio.

To gain exposure in these uncertain times, instead of buying an index fund where poorly performing sectors can negate outperforming sectors, Specialised Investment Managers with market access, sector know-how and a dedicated team could possibly enhance the risk-return profile of this important area of your portfolio. 

Disclaimer

Source: Franklin Templeton, Western Asset. Data as of 31 August 2020 unless otherwise stated. 

Legg Mason Asset Management Hong Kong Limited and Legg Mason Asset Management Singapore Pte. Limited are indirect wholly owned subsidiaries of Franklin Resources, Inc.

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