ABS: the brakes are off with the UK leading the way
We recently highlighted in our 2024 outlook our expectations of significant inflows into fixed income to be an important technical driver of performance in the year ahead. As confidence has continued to grow about the downward path of inflation, markets have ramped up bets of aggressive easing coming through, with the Fed’s own dot plots from its December meeting pointing to three rate cuts in 2024.
With all-in yields in credit still above their longer-term averages and developed market central banks poised to begin lowering borrowing costs, global fixed income funds have begun reversing the trend of negative flows largely seen over the last two years, with global corporate credit funds experiencing inflows in recent weeks.
Within European investment grade (IG), funds have now recorded a ninth straight week of inflows, including the largest two-week inflow in more than two years into short-term IG funds. Euro high yield funds posted a third straight week of positive flows, with last week’s being the strongest in six weeks.
A similar trend has been taking place in the US, with high yield funds recording an inflow of $10bn in November and a further $2.7bn in December, after suffering the worst month of outflows for 2023 in October. Importantly, the flow of cash back into higher yielding alternatives, like corporate credit, comes at a time in which the global HY market is getting smaller, primarily driven by rising stars and muted primary issuance in 2022 and 2023. In the US, for example, the face value of the HY market has shrunk to ~$1.3trn, roughly 15% lower than its 2021 peak, adding to the positive technical in this market with this influx of cash chasing a smaller pool of debt.
Other areas of credit, which had been less favored by investors in recent months, such as global EM debt, also finished the year on a more positive note with back-to-back weeks of inflows after 21 weeks of non-stop outflows, while US leverage loans also recorded inflows in nine of the last 10 weeks of the year. The trend has certainly been shifting.
Following a relentless rally in credit markets to cap off a very volatile 2023, perhaps some investors are now asking themselves if the positive flows into corporate credit will continue. One key point that we previously noted is the anticipated flow of cash out of cash-like products and back into fixed income. It is worth highlighting that during the first week of the year, money market fund assets increased once again, this time by $123bn, rising to a fresh record of $5.96trn. With base rates widely expected to have reached their peaks in the major economic regions, and as central banks get closer to a first rate cut, we continue to believe that cash as an asset class will look less appealing and expect that some of these assets will find their way back to other pockets of fixed income.
The forward path of monetary policy will continue to act as the main driver of markets in the near term, and the timing and magnitude of rate cuts from developed markets central banks will unquestionably be driven by upcoming economic data over the next few months. But the progress made on the inflation front (and economic growth estimates that continue to be revised higher in the US) has increased confidence in the central banks’ ability to engineer a soft landing. Barring any significant changes in the macro picture, we continue to expect assets to flow back into credit and other areas of fixed income, which currently provide very attractive all-in yields, a powerful technical driver of performance and perhaps in many cases limiting the downside in the event of a market sell-off.