IN FOCUS6-8 min read

Why 2023 is the year to go global for credit

Although momentum is building behind credit as an asset class, the best opportunities might only be available for those with a truly global approach.

27/02/2023
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Authors

Janina Sibelius
Investment Specialist
Rajeev Shah
Global Credit Strategist

After a grim 2022, things are looking up for credit again.

New enthusiasm has reinvigorated the credit market recently as investors have flocked back in search of much-needed diversification. But how to avoid the many pitfalls in the market and where can we find the best opportunities in credit this year?

With inflation still high, causing central banks to remain hawkish, there is both good and bad news on the horizon. The good news is that it looks like central bank tightening is starting to bite and inflation has started to come down from peak levels. This brings new opportunities for credit investors looking to take advantage of the divergence in the global market.

Martha Metcalf, Head of US Credit Strategies, said: “The immediate effects of central banks’ tightening of financial conditions have moved at a varying pace in each market and we believe regional allocation and rotation offer opportunities to add value in 2023. China’s re-opening will amplify these differences in both pace and magnitude.”

There are signs that inflation has begun to fall a little

Charts - global credit

But despite inflation starting to fall back, it could remain sticky. This has prompted expectations for central banks to maintain higher interest rates for longer, causing greater dispersion in the credit market as investors price in the risk.

Rick Rezek, Global Credit Portfolio Manager, thinks higher rates finally offer investors the opportunity to generate income from their fixed income allocation.

“We believe higher rates will draw capital into the asset class from both institutional and retail investors. In addition, growing dispersion between regions, sectors and issuers will expand the opportunity to generate alpha in 2023,” he said.

Diversifying globally is not without its risks, however. With higher interest rates there is a real worry that central bank action will stifle growth to a point of recession. The ongoing war in Ukraine and potential energy shocks also remain a source of caution for credit investors. Later in the year, the US debt ceiling could be a source of volatility.

Yet, good investment opportunities remain abundant for those with a broad view across the markets and the ability to pick the winners across sectors from each region.

In Asia, for instance, China’s re-opening is set to provide a boost to tourism and the services sector in the region, similar to what we saw in Europe after the pandemic restrictions were lifted.

Europe is also poised to benefit from the re-opening of its largest Asian trade partner, with Schroders economists forecasting a 0.5% boost to eurozone gross domestic product (GDP) as a result. Opportunities can also be found in some cyclical sectors in Europe, given that the cost-of-living crisis is not as nuanced as expected and governments have responded well in terms of protecting the economy from the sharpest falls.

We are starting to see exports picking up

Charts - global credit

In the US, the market has seen some tightening but attractive opportunities can still be found across sectors. For instance, fundamentals for financials still look solid, despite the recent underperformance, as banks remain well capitalised.

Navigating through different trends across regions

Increased geopolitical instability continues to cause headaches for companies manufacturing in countries where political conditions have deteriorated over the past years. As companies increasingly look for countries that offer stable conditions for production, many have decided to move production closer to home - a trend called nearshoring.

Not surprisingly, the biggest winners are countries such as Thailand, Malaysia and Vietnam, along with Mexico, that have better relationships with the West, especially the US, and where labour costs are still very low.

The West will also have its winners, although recognising them will take more careful consideration. This is why active investment and careful selection will be essential when investing globally this year.

Martin Coucke, Global Credit Portfolio Manager, said: “Direct winners are not as obvious as it’s very difficult to re-shore in the US and Europe and keep costs at the same level, meaning re-shoring can either be inflationary or negative for margins. That said, re-shoring can be quite capex-intensive, such as in the case of semi-conductors, and could require financing in the bond market. That could offer an opportunity for bond investors to finance interesting companies with more sustainable business models.”

So although the credit markets are poised to offer investors both higher yields, as well as capital appreciation opportunities from lower yields and tighter credit spreads, there are many regional pitfalls to look out for. Nimble, active investors will be best positioned to take advantage of the new opportunities.

Authors

Janina Sibelius
Investment Specialist
Rajeev Shah
Global Credit Strategist

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Schroders (Bermuda) Limited is an indirect wholly-owned subsidiary of Schroders plc and is licensed to conduct Investment Business by the Bermuda Monetary Authority.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.