Curmi & Partners

U.S. and European Credit Markets: 2020 Review and 2021 Outlook

by Simon Gauci Borda

2020 Economic & Credit Market Forecasts

The outbreak of the pandemic caught the global economy off-guard, as estimates published towards the tail-end of 2019 had to be revised downwards to factor in the impact of the pandemic. Bloomberg forecasts published in the latter months of 2019 showed that global real GDP growth in 2020 was expected to be 3.2%, with the U.S. and Euro Area economies expected to grow by 1.8% and 1.0% respectively. However, these same forecasts had to be revised once it became apparent that economic activity and business conditions would decline. In fact, at the time of writing, updated forecasts show that the global economy is expected to contract by 4% in 2020 on a real GDP growth basis, while the U.S. and Euro Area economies are expected to contract by 3.9% and 7.7% respectively.

Projections published during the fourth quarter of 2019 also showed that fixed income markets were expected to experience a slight deterioration as spreads were initially expected to widen in 2020. The U.S. investment grade and high yield markets were expected to see a widening in spreads to 115bps and 425bps, while European investment grade debt and high yield debt were expected to see a widening of spreads to 112bps and 380bps. Contrary to the economic projections, the forecasts for the credit markets proved to be over-estimated as currently (data as of the 24th of December) U.S investment grade and high yield spreads are 99bps and 375bps respectively while European investment grade and high yield spreads stand at 93bps and 354bps respectively.

Credit Market Sell-off and Recovery

The pandemic’s initial effect on credit markets was a significant widening of spreads during the months of February and March across both sides of the Atlantic and across both investment grade and high yield markets as investors perceived both a higher level of uncertainty and risk. By the end of March, European investment grade and high yield spreads had increased to 241bps and 806bps respectively, while U.S. investment grade and high yield spreads widened to 285bps and 867bps, far beyond all expectations set just a few months earlier.

During the months that followed, the U.S. and European credit markets experienced a gradual improvement as spreads tightened across the board due to certain actions taken by the fiscal and monetary authorities together with certain market events. The first significant event was the easing of monetary policy conditions. Global central banks either kept or lowered their benchmark interest rates and ramped up or initiated bond buying programmes of unprecedented scale. Secondly, governments introduced fiscal stimulus measures which sought to assist individuals and businesses affected by the pandemic. Thirdly, credit markets experienced a heightened level of debt issuance as corporates scrambled to raise new debt in order to increase their liquidity levels and strengthen their balance sheets in view of an expected prolonged period of lower revenues and difficult economic conditions. This demonstrated that issuers still enjoyed access to credit markets and maintained the ability to raise financing even in times of extreme uncertainty. Finally, the announcements made by pharmaceutical companies Pfizer and Moderna during the fourth quarter of 2020, with the discovery of a vaccine also contributing to investor sentiment and an improvement in credit market conditions.

2021 Economic and Credit Market Outlook

The global economy is expected to return to growth in 2021 with updated consensus projections forecasting global growth of 5.2%, while the U.S. and Euro Area economies are expected to grow by 3.8% and 5.2% respectively. The expected economic rebound, together with the continuation of the accommodative stance adopted by central banks and the rollout of the vaccine, are expected to contribute to the continued improvement in credit market conditions. Forecasts produced by Goldman Sachs claim that by the fourth quarter of 2021, U.S. investment grade and high yield spreads are expected to be at 100bps and 340bps respectively, while European investment grade and high yield spreads are expected at 96bps and 330bps respectively. The pathway between where we are and these spread forecasts remains unclear as in the short-term, risks relating to the rollout of the vaccine, and any potential lags in the pickup of economic activity could derail such positive projections.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.