Short & Intermediate Duration: Q2 2021 Recap, Performance & Outlook

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Short & Intermediate Duration: Q2 2021 Recap, Performance & Outlook

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Short & Intermediate Duration Portfolio Team
JUN 30, 2021

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Investment Grade Credit

Recap: In the second quarter we witnessed a further grind tighter in credit spreads, approaching record low levels for the broad credit indices. The generally uninterrupted move lower in spreads over the past three months, in addition to the decline in volatility, lack of new issue spread concessions and limited spread dispersion across issuers and subsectors underscore the stretched feel of corporate credit valuations with seemingly little room for incremental spread tightening. Neither the hawkish tilt adopted by the Federal Reserve at the June FOMC meeting and Chair Powell in his post-meeting remarks nor last month’s surprise announcement of the Secondary Market Corporate Credit Facility’s wind-down by year-end unsettled credit markets. The corporate new issue calendar continued to be steadily busy throughout the second quarter with new issue spread concessions increasingly hard to come by. However, investors remained undeterred, readily absorbing issuance in an effort to invest the consistently steady torrent of inflows into the space. The earnings season concluded with first-quarter year-over-year earnings growth well above forecasts as companies benefited from the pickup in economic activity, supporting strong top-line revenue growth as seen in the U.S.’s first-quarter’s real GDP growth of 6.4%.1 Investors were also buoyed by the increased pace of reopenings across most major economies with the pace of vaccinations picking up meaningfully over the quarter, leaving nearly 60% of American adults fully vaccinated2 and unleashing some of the pent up demand stored up during more than a year of pandemic-related lockdowns. Consumer spending has also been bolstered by several rounds of stimulus checks. The big jumps in many commodity prices during the quarter coupled with supply chain bottlenecks and raw materials shortages, in addition to causing inflation measures to move higher, also prompted a broad cross-section of companies to highlight the negative impacts on their cost structures. Layering those higher expenses on top of the increased wage costs many companies have been facing due to the U.S. labor market’s supply constraints, we foresee further pressure on operating margins over the coming quarters, potentially extending the necessary process of balance sheet repair and improvement in credit metrics required after pandemic-driven measures pushed leverage to record highs. Nonetheless, the investment grade credit market remained notably complacent over the second quarter, which raises concerns over how well the market is prepared to adjust to the eventual removal of the historic amount of monetary and fiscal support initiated at the onset of the pandemic.