Richard Woolnough believes that corporate bonds offer value for investors and they are being overpaid for default risk.
How have fixed interest markets behaved since the onset of the credit crisis?
Since the start of the credit crunch 3 years ago, short-term interest rates in the US, Europe and the UK have collapsed to near zero. 10 year government bond yields across the respect-ive economies have fallen by around 2% over the period.
Whilst the fall in interest rates and yields has been a great gift for government bond investors, the global economy has been suffering one of its worst recessions since World War II.
It has also been an excellent time to be an investor in corporate bonds. Yields on corporate credit shot up in the latter half of 2008 as the corporate bond market began to price in a re-run of the Great Depression. This provided an extremely attractive buying opportunity. The asset class has rallied sharply since early 2009 as corporate bond spreads have tightened back to levels seen before the collapse of Lehman Brothers.
What are your views on the likelihood of the UK going into a double-dip recession?
We have had an anaemic economic recovery in the UK despite the quantitative easing (QE) that has been thrown at the problem. However, my view is that I still don't think there is going to be a double-dip recession. It looks more likely that we will continue to see low, but positive, economic growth in the developed economies. This is the kind of environment in which corporate bonds have traditionally performed well.
However, the longer the economy remains weak, the more it looks like it has become a structural change, not just a cyclical downturn. It has now been 3 years since the credit crunch began, and the arguments that this is not a normal economic cycle are starting to become more compelling. Within the Fixed Interest team at M&G, we continually evaluate such trends to form our view on the markets.
What is your outlook for interest rates and bonds?
The US Federal Open Market Committee decided in recent weeks to reinvest the assets they purchased through QE, which is an acknowledgement that it is still not time to start tightening monetary policy. There is also the possibility that the Bank of England may have to re-start QE. Although the US has taken drastic measures to prop up its economy - such as reducing interest rates to near zero, a move followed by much of the developed world, and by using unconventional measures such as QE - the global economic recovery remains in doubt.
It is fair to say that those central banks around the world that are currently running ultra-easy monetary policy will continue to do so for some time to come. As a result, low interest rates are likely to persist for some time - which should continue to be positive for the bond markets.
Where do you see the best value for investors?
I still want to own corporate credit because I think that a lot of companies have already cut costs, leaving them in better financial health in fact than some governments. Also, despite spreads having tightened considerably, corporate bonds are still priced for recession and a higher level of defaults than they have actually experienced historically. I therefore believe that corporate bonds continue to offer value for investors. I think investors are being overpaid for default risk, especially in the investment grade space (bonds rated BBB and better), but also in certain parts of the high yield market.
And unlike many governments, which are continuing to issue bonds to finance their deficits, a lot of corporate refinancing has already been done. So there is less corporate bond issuance taking place. Relative to government bonds, the supply of corporate bonds is falling, and this makes them comparatively more attractive.
Overall, I think corporate credit is more attractive than either government bonds or cash.
To hear more from Richard Woolnough visit the M&G fixed interest team's blog, www.bondvigilantes.co.uk
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