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Brandywine Global’s Brian Kloss: Global Credit Outlook 2022

Brian Kloss, Portfolio Manager, Global Fixed Income Team at Brandywine Global, a specialist investment manager of Franklin Templeton, provides his 2022 outlook on the impact of COVID-19 and fiscal policy changes on global credit markets and his insights on where the investment opportunities lie in 2022.

“‘Given expectations for a vaccine and the tremendous policy responses at work, we see a very high likelihood of a cyclical recovery’ was how we started this commentary a year ago in December of 2020. It does feel as if we could start this year’s commentary with a similar outlook. That being said, looking out to 2022, one can expect some events to be similar while others are going to be quite different. Vaccines, therapeutics, Delta, Omicron, Pfizer, Moderna—the list of pandemic nomenclature goes on, and all these terms will continue to be focal points for markets as we as a global community continue to deal with that virus we all wish we could forget—COVID-19. As we move into the third calendar year managing and living with COVID, markets continue to adjust and adapt as scientists and policymakers continue to make significant inroads, all while the virus eventually moves from a pandemic to endemic.

“However, the unprecedented monetary and fiscal policies we discussed last year are now transitioning to the next stages as the role they played during the pandemic begins to revert back to a more “normal“ or conventional policy. Fiscal policy will be expansionary but nowhere near what the markets saw in the previous two years. Meanwhile, regulatory and tax burdens will be increasing. Most importantly, monetary policy will become more restrictive as the U.S. Federal Reserve embarks on ending its quantitative easing program, possibly on an accelerated basis. Embarking on tapering first will allow Fed policymakers to assess market conditions before they move to raise the federal funds rate. These tightening conditions should arrest the spread tightening that we have seen in corporate credit over the last eighteen months. However, economic conditions should remain supportive of credit spreads, and we anticipate minimal defaults across global credit assets.

“While they may not rise to the extent of 2021’s record-breaking year, corporate profits in 2022 should continue to surprise to the upside, especially in the first half of the year. There are two strong tailwinds working in their favour and supporting the market heading into the new year. First, supply constraints may have peaked, which should relieve cost pressures across multiple sectors. Second, companies continue to exhibit a high degree of pricing power due to strong demand from consumers. Consumers, in aggregate, possess an enormous amount of savings ready to deploy as the economy continues to renormalize. The second half of the year becomes a bit murkier as global central banks may become less accommodating if inflation persists.

“Therefore, we remain constructive on risk assets, expressing that view across corporate credit markets by utilizing our strong, proprietary underwriting model and deploying a very nuanced allocation to select credit instruments. Our focus continues to be on basic industries, capital goods, energy, and other cyclical sectors in both developed and emerging markets. We favour those industries that have a more cyclical tilt, like autos and mining, which should see marked improvement as the economy rebounds from the lockdowns but will be very mindful to the risks we discussed above around tightening monetary and fiscal conditions. Similar to last year, we believe higher-quality assets offer the best risk/return profile and should remain supported even if there is risk around monetary policy. We are generally avoiding both ends of the credit-quality spectrum, with high quality offering limited total return potential, and lower-quality bonds still susceptible to hiccups in the global economic recovery.”

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