After an extraordinary year, 2021 looks set to see the return of some semblance of normalcy, should the positive signs over a vaccine for Covid-19 become reality.
This would be welcome for corporate bonds, with continued policy support, search for income and pockets of attractive valuation giving a broadly positive outlook overall.
Added to the potential for vaccines to be approved and distributed, the US election outcome has removed uncertainty and raised the possibility of an economic stimulus package, albeit the size and timing is uncertain. These factors together have at least provided optimism that a far more positive year is in the offing. But there remain questions around both and we expect central banks to remain highly supportive.
We go into 2021 with corporate debt at record levels. Companies raised huge sums through bond markets in 2020, to ensure they could get through the crisis. Indications are that this has peaked, corporate cash levels have increased, and balance sheets could start to improve.
Some companies will have overreached, however, and it will be important for credit investors to differentiate in 2021.
The search for yield will likely remain a theme, with a substantial proportion of global bonds either zero or negative yielding. Credit yields have fallen significantly since March (yields and prices move inversely), in some cases entirely retracing the negative moves seen in the crisis.
There are still pockets of value though, in all corners of the market, and security selection opportunities due to differentiation in company and sector valuations. Sectors most affected by Covid have potential to further recover. High yield and emerging markets broadly look appealing, but require a judicious approach.
Policy Backdrop Remains Supportive
While the potential for vaccines and a US economic stimulus paint a positive picture for 2021, there remains plenty of uncertainty. With numerous countries still in lockdown, a fragile recovery, unemployment markedly above pre-Covid levels and low inflation, it is likely central banks will continue policy support.
The Federal Reserve is expected to increase its balance sheet, mainly through purchases of Treasury bonds and other financial securities, to the tune of $2 trillion in 2021. This figure is lower than in 2020, but more than double the level seen in any year prior to that.
The expectation is that gradual normalization in the economy and societies will result in moderately higher government yields over the course of the year, but policy measures should limit any upward moves. This will be broadly supportive for corporate bonds.