Although the pandemic is still raging in many areas of the world, the recent developments on the vaccine front raises well-founded hopes that at least most of the industrialized world can return to something resembling (a new) normal during the course of 2021. This is the backdrop for these comments about the market outlook for Nordic fixed income for 2021. But first a look at the drama and developments of 2020 in the Nordic markets.
Nordic credit markets 2020
2020 was an unprecedented year in the Nordic fixed income markets. A combination of factors led to the largest spread widening we have ever seen in the Nordics. This is in contrast to global spread developments where swift action from the major central banks prevented credit spreads from reaching the levels we saw during the financial crisis in 2008 (and in Europe well below the levels during the government debt crisis in 2011).
US and European credit spreads:
In contrast credit spreads in the Norwegian and Swedish credit markets went to wider levels than we saw during the financial crisis, and in Sweden we also saw 35 individual credit funds having to close for redemptions.
Credit spreads of various maturities for Norwegian banks
The main reason that the initial impact from the pandemic to credit markets was larger in the Nordics, was that, whereas the major central banks (The Fed, ECB) had the necessary tools sharpened and ready (mainly in the form of QE that also included corporate bonds), and acted swiftly to mitigate the effects in the bond markets, this was not the case in Norway and Sweden. Sweden did have a QE program up and running but this program did not include corporate bonds. Massive outflows from Swedish credit bond funds thus led to the market collapsing. In June, well after spreads had normalized, the Swedish central bank announced that they would start buying corporate bonds from September 2020. The program is quite small, 10 bn. SEK, but as the central bank states in the description of the program it is instigated to establish a presence in the credit market to be able to swiftly increase the program if necessary. In this way the Swedish central bank seeks to mitigate what was shown to be a weakness in the Swedish credit market in March.
In Norway the problem was a different one. The outflow from credit funds was not that massive, but the unprecedented weakening of the NOK created a huge demand for cash to put up as security in currency hedging contracts, not least from the life insurance and pension sector which has most of their investments in foreign currency. To generate the necessary cash, investors tapped their liquid NOK money market and bond portfolios leading to a massive selling pressure in the market, resulting in a spread widening that was both larger and faster than anything witnessed during the financial crisis. This effect was seen throughout all credit qualities, but the resulting spread widening was naturally largest for high yield.
NOK against EUR, USD and SEK
Just as the Swedish central bank was unprepared for the specific problems in the Swedish market, the Norwegian central bank had not seen the link between the sharp weakening of the NOK and the functioning of the domestic credit market and they tried to solve the underlying problem by showering the banks with liquidity, to no avail. As March ground on Norges Bank started to realize where the problem was located and on March 20th they announced that they, for the first time since 1998, considered intervening in the FX market. We have since learned that they did intervene, buying relatively small amounts of NOK (3.6 bn. NOK) on Thursday 20th and Friday on March 21st. This was enough to stabilize the NOK and thereby also the credit market which turned around March 21st. Thus, it is relatively obvious to us that both the Swedish and the Norwegian central bank have gone through a learning process in 2020 and that they have prepared and adapted their toolboxes based on this learning. This makes us quite confident that the Nordic central banks will be better prepared for potential future situations, just like the fed and ECB turned out to be in 2020.
Macroeconomic developments in the Nordics
Just like in the rest of the world the pandemic has hit the Nordic economies quite hard. Measures to prevent contagion have been particularly difficult for service industries, leading to a fall in GDP and increased unemployment. However, the Nordic economies have been less affected by the pandemic than many European countries and even the US. Some of the underlying strengths in the Nordic region, such as strong public finances, well developed social security, and health systems and high levels of trust in the populations have helped ameliorate the effects of the pandemic. Thus GDP estimates for countries in the Nordics for 2020 and 2021 tend to be somewhat less bleak than for many other regions (except for China and parts of Asia).
So far we also see that when it comes to measures such as unemployment, retail sales, and house prices, the Nordic countries have performed well in relative terms.
Accumulated gains/losses in retail sales 2020
Outlook for 2021
The economic effects of the pandemic will clearly be felt well into 2021, both globally and in the Nordic region. The resurgence of virus cases both in the US and in Europe has also been felt in the Nordic countries. Just as elsewhere, this has led to the re-introduction of preventive measures limiting social contact and hampering economic activity. It now seems quite evident that in the absence of measures the contagion will run rampant, an observation that leads to the conclusion that we will either live in a start-stop world for still some time, or that we will find some combination of measures which keep contagion level. In either case, it now seems that we will have to live with some curbs on economic activity until a sufficient proportion of, at least the most vulnerable citizens have been vaccinated. This reality will most likely lead to a somewhat weaker than anticipated GDP development over the next couple of quarters, both in the US, in the Euro-area and in the Nordic countries. Luckily, the recent developments on the vaccine front, and in particular the indications that early vaccines will be highly effective, create a well-grounded hope that after a potentially difficult winter we can return to something resembling normal activity sooner than we feared. In our view, these two opposing dynamics in sum make the estimates for GDP growth from the Swedish and Norwegian central banks shown above quite reasonable.
Given this backdrop, we think the outlook for the Nordic credit market is pretty decent. It is hard to argue that investment grade credit is cheap anywhere, as spreads have tightened to levels that we consider to be well inside a normal range. However, given that we think that the underlying theme for the world in general is recovery for 2021, and that the Nordic countries will be at the vanguard of the recovery, we still see potential in Nordic IG credit spreads. Not least because the 2020 crisis led the last remaining Nordic central bank with a positive central bank rate (Norges Bank) to cut to zero. With little outlook for central bank rate hikes or substantially higher interest rates over the next couple of years, we believe that credit spreads can grind tighter in the Nordics.
When it comes to Nordic high yield, we definitely think there is still room for spread tightening in 2021. Again, based on the underlying recovery theme and also observing that the recovery for Nordic high yield spreads has been less pronounced than for investment grade, we expect 2021 to be a good year for Nordic high yield.
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