U.S. SECURITIES AND EXCHANGE COMMISSION

U.S. SECURITIES AND EXCHANGE COMMISSION

Division of Economic and Risk Analysis

DERA

Economic

and

Financial

Outlook

FEBRUARY

15, 2021

Table of Contents

Key Highlights...................................................................................................................................1

The Path of COVID-19 Cases Is Uncertain.......................................................................1

The Effects of the COVID-19 Recession on Employment Remain Uneven.........1

Equity Markets Have Recovered Faster than the Overall Economy....................2

Both Households and Firms Are Accumulating Cash...............................................3

Macro-Financial Overview...........................................................................................................5

Economic Fundamentals and Growth.............................................................................5

Monetary Policy and Interest Rates..................................................................................6

Financial Market Signals.......................................................................................................9

Market Segments........................................................................................................................... 11

Markets....................................................................................................................................... 11

Mutual Fund and ETF Investors....................................................................................... 12

Borrowers, Securities Issuers, and Capital Formation............................................. 14

Spotlight........................................................................................................................................... 17

CDS Pricing and Credit Events in 2020........................................................................ 17

The Division of Economic and Risk Analysis (DERA) advances the Commission’s statutory mission to protect

investors, maintain fair, orderly, and efficient markets, and facilitate capital formation through sound economic

analysis and rigorous data analytics. DERA engages across the entire range of the agency’s functions, including

rulemaking, examination, and enforcement. Its multi-disciplinary analyses are informed by research insights and

they rely on the knowledge of institutions and practices when examining regulatory and risk-related matters. DERA

assists the Commission in its efforts to identify, analyze, and respond to economic and market issues, including

those related to new financial products, investment and trading strategies, systemic risk, and fraud. DERA’s data

analytics work develops a variety of financial and market data analysis tools, gathers economic statistics, and

promotes data standards. DERA economists publish regularly in top peer-reviewed journals, including the Journal

of Financial Economics, the Journal of Labor Economics, and the Review of Financial Studies.

DERA Research Staff: Chandler Lutz (Lead Economist), Gregory Allen, and Pamela Urban.

OPA Design Team: Chris Gamboa-Onrubia, Zehra Sikandar, and Jennifer White.

Disclaimer: The SEC disclaims responsibility for any private publication or statement of any SEC employee or

Commissioner. This article expresses the authors’ views and does not necessarily reflect those of the Commission,

the Commissioners, or members of the staff. This report contains a non-exhaustive aggregation of information

and is one of several elements of the SEC’s risk and market monitoring efforts.

sec.gov/dera

Key Highlights as of February 15, 2021

Following the historic and unprecedented COVID-19 economic shock in March 2020, financial

markets appear to have largely recovered as aggregate equity prices have risen and credit

spreads have tightened. While economic output is expected to expand during 2021, forecasters

predict that gross domestic product (GDP) will remain below its pre-pandemic trend through

2021, as the uneven economic recovery continues to weigh on certain sectors. Capital market

activity has also recently accelerated as corporations have increased borrowing and as more

firms have entered public markets through initial public offerings (IPOs) or special purpose

acquisition companies (SPACs). Both households and firms in aggregate have bolstered their

cash positions by increasing savings rates or taking advantage of historically low interest rates.

The Path of COVID-19 Cases Is Uncertain

After Rising During 2020Q4, New U.S. COVID-19 Cases and

Deaths Have Recently Dropped as the United States Ramps Up

Vaccine Distribution: The number of new confirmed COVID19 cases increased during 2020Q4 and peaked at about 1.75

million per week in early January 2021 (Figure 1.1A). This

increase in cases prompted some local and state authorities to

reverse or delay reopening protocols as a response. Yet as the

United States has begun distributing COVID-19 vaccines, new

confirmed COVID-19 cases have dropped to a weekly rate

just below 700,000 as of February 12, 2021. Similarly, newly

reported deaths reached nearly 23,000 per week in mid-January

2021 but have since fallen slightly (Figure 1.1B). CDC Data retrieved February 12, 2021, indicate that 35.8

million Americans have received at least one dose of a COVID-19 vaccine.

The Effects of the COVID-19 Recession on

Employment Remain Uneven

The Effects of the COVID-19 Recession on Employment

Remain Uneven Across Sectors: Following the partial economic

slowdown caused by COVID-19 health protocols, by April

2020 employment as measured by non-farm payrolls fell nearly

15% from its pre-pandemic highs (Figure 1.2; green line). Then,

as the country adjusted to public health measures and as local

economies partially reopened, job gains quickly accelerated.

These gains were concentrated in the sectors most hard-hit by

the economic lockdowns associated with the pandemic (DERA

Economic and Risk Outlook, July 2020; p. 1). While recent

DERA ECONOMIC AND RISK OUTLOOK | 1

total job growth has slowed (green line), employment excluding the leisure and mining (mining, oil

and gas, etc.) sectors continues on a slight upward trend (red line). Thus, the COVID-19 recession

continues to have outsized adverse effects on certain sectors. Yet there have also been relative bright

spots across the U.S. jobs landscape. For example, employment in the financial activities sector (Figure

1.2; blue line), including the banking, insurance, and real estate industries, was relatively flat in 2020.

Similar positive employment dynamics have also transpired in other industries, such as the online

retail and technology sectors.

Equity Markets Have Recovered Faster Than

the Overall Economy

The Pace of the Equity Market Recovery Has Eclipsed The

Economic Recovery: Although recent data suggest that the

economy remains below full employment (Figure 1.2), equity

market performance coming off lows in March 2020 has been

notable. Figure 1.3 highlights the relatively faster pace of the

recovery in equity markets by plotting the growth in actual

values and forecasts of GDP (panel A; forecasts tabulated by

MarketWatch) and the S&P 500 (panel B) from 2019Q4.

Forecasters expect GDP to return to pre-pandemic levels in July

2021, while the S&P 500 has already increased by about 20%

compared to January 2020 levels.

As noted in the July 2020 issue of the DERA Economic and Risk Outlook, several factors in isolation or

in combination may have contributed to the recent run-up in equity prices, including (1) COVID-19-induced

increases in the frequency of internet shopping and remote work—trends that favor large technology firms,

which constitute a substantial portion of value-weighted equity indices; (2) low expected interest rates that

increase the present value of future profit streams; or (3) anticipation that the pandemic will not continue

much longer, in part because of increased vaccine availability.

Moreover, recently there may have also been elevated equity

purchases or options trading by retail investors.

Certain Equity Market Valuation Proxies Are Near Historical

Highs. Yet After Accounting for Low Current Interest Rates,

Valuations May Be in Line With Historical Levels: The recent

rise in stock prices, especially compared to economic growth,

has coincided with increases in certain equity market valuation

proxies. Figure 1.4A plots the S&P 500 market value relative to

GDP, where the blue bars are NBER recessions and the yellow

bar represents the start of the COVID-19 recession through the

end of the data sample. Not surprisingly, given the considerable

equity price growth compared to the relatively weaker economic

growth (Figure 1.3), the ratio of the S&P 500 market value to

GDP has increased markedly since March 2020 (Figure 1.4A).

2 | U.S. SECURITIES AND EXCHANGE COMMISSION

Currently, the S&P 500 market value is about 1.5 times the size of GDP, surpassing the previous

peak in this ratio of 1.3 in 2000. Similarly, the forward P/E (price / earnings) ratio for the entire

stock market (the price relative to estimated earnings for the next 12 months) shows that equity

prices have recently increased sharply relative to expected earnings but have not reached the levels

seen during the early 2000s (Figure 1.4B). As noted above, several factors may have contributed

to the recent rise in equity prices relative to economic growth or expected earnings. In particular,

sustained low interest rates increase the present value of future profits. They also may make

equities attractive relative to bonds, pushing traditional valuation proxies higher (e.g., Figure 1.4,

panels A and B). To account for the current historically low levels of interest rates, Figure 1.4C

plots the expected earnings yield from equities (next 12 months expected earnings / price) minus

the 10-year Treasury yield. Spikes in the earnings yield–Treasury spread may indicate that equity

prices are low, suggesting that investors perceive equity investments as risky and therefore expect

to be better compensated for holding stocks versus bonds (e.g., a higher earnings yield relative to

the 10-year Treasury). This occurred, for example, at the height of the Great Recession in 2009.

In contrast, when the earnings yield–Treasury spread is low, like at the height of the tech bubble

in 2000, investors may expect little additional compensation for holding stocks and thus may

expect relatively lower subsequent equity market risk. The most recent data shown in Figure 1.4C

indicate that earnings yield–Treasury spread is in line with historical levels, perhaps suggesting that

investors expect approximately average levels of risk in equities going forward. That said, as noted

above, several factors may be contributing to the recent rise in equity prices.

IPO Market Activity Accelerated During 2020, Especially For

SPAC IPOs: Investor interest in SPACs jumped in 2020 (Figure

1.5). In 2020 through SPACs, firms raised $70 billion in 227

deals, up from $11 billion in 2019. Activity in the traditional

IPO market also expanded in 2020, with 189 deals worth $71

billion, the largest dollar issuance since 2014.

Both Households and Firms Are

Accumulating Cash

With the Onset of COVID-19-Induced Economic Uncertainty,

Both Households and Firms Began Accumulating Cash:

As COVID-19-induced economic distress and uncertainty

permeated across markets, both households and firms

bolstered their aggregate cash holdings. Indeed, the household

personal savings rate spiked to over 30% in April 2020 (Figure

1.6A). This elevated savings rate is likely due to a combination

of factors, including precautionary savings by households,

COVID-19-induced partial economic lockdowns that limited

consumption choices and household mobility, and a reduction

in debt-service payments (e.g., mortgage payments through

refinances) attributable in part to historically low interest rates.

DERA ECONOMIC AND RISK OUTLOOK | 3

As local economies have reopened and households have adjusted to COVID-19 health protocols

and financial stress has ameliorated, the personal savings rate has retreated somewhat but

remains nearly double its pre-pandemic levels. Similarly, many firms have increased available

cash on hand, perhaps because of uncertain revenue outlook and attractive interest rates.

Figure 1.6B plots the available days of cash on hand for the median public firm and shows

that days of cash on hand increased markedly following the start of the COVID-19 recession.

Data as of 2020Q4 indicate that the number of days of cash on hand for the median firm

remains about 30% above its pre-pandemic levels.

Data Sources: Figure 1.1: The New York Times, based on reports from state and local health agencies (available at https://github

com/nytimes/covid-19-data); and Johns Hopkins University Center for Systems Science and Engineering (CSSE) (available at

https://github.com/CSSEGISandData/COVID-19). Figure 1.2: Bureau of Labor Statistics (BLS), retrieved from The Federal Reserve

Economic Database (FRED) (IDs: PAYEMS, USCONS, MANEMP, USTPU, USINFO, USFIRE, USPBS, USEHS, USSERV, USGOVT).

Figure 1.3: Datastream; U.S. Bureau of Economic Analysis (BEA), retrieved from FRED (IDs: GDPC1). Figure 1.4: Datastream.

Figure 1.5: Capital IQ. Figure 1.6: BEA; retrieved from FRED (IDs: PSAVERT); Datastream.

4 | U.S. SECURITIES AND EXCHANGE COMMISSION

Macro-Financial Overview

The macro-financial environment is encapsulated in three key aggregate drivers of financial

decisions: (1) economic fundamentals and growth; (2) monetary policy and the interest rate

trajectory; and (3) financial market signals and credit conditions.

Economic Fundamentals and Growth

Key Takeaway: GDP is expected to expand during 2021 but remain below its prepandemic trend through the end of the year. More broadly, economic indicators are

mixed, signaling that certain sectors of the economy are recovering faster than others.

Figure 2.1 plots real quarterly GDP dating back to the Great

Recession (blue line), as well as GDP forecasts (median forecasts

tabulated by MarketWatch; green line). The U.S. economy

was consistently expanding at a 2–3% annual real rate before

the onset of the COVID-19 pandemic. Then the United States

entered into a COVID-19-induced recession in March 2020, and

GDP fell 10.1% during the first half of 2020. Economic growth

then surged in 2020Q3. Going forward, economic output is

expected to rise swiftly through 2021 (Figure 2.1; green line) but

remain below its pre-pandemic trend. Indeed, assuming that in

the absence of the COVID-19 recession the U.S. economy would have grown at a 2% annual rate (Figure

2.1; red line), the lost economic output due to the COVID-19 outbreak through 2020Q4 was approximately

$1 trillion. If the path of GDP follows analysts’ predictions (Figure 2.1; green line), lost economic output

through 2021, compared to the 2% growth counterfactual, will reach $1.5 trillion.

The impact of the COVID-19 recession on key economic indicators remains mixed, as seen in Figure 2.2.

Broadly, all economic indicators signaled distress in the immediate wake of the COVID-19 recession. Yet

following the initial shock, the pace of the recovery has varied across economic proxies, suggesting that some

parts of the economy are recovering faster than others. For example, Figure 2.2A shows job growth quickly

accelerated during mid-2020 but has since leveled off. Indeed, the number currently employed, as measured

by non-farm payrolls, is nearly 10 million below its pre-pandemic highs. Similarly, consumer confidence

has remained weak since March 2020 (Figure 2.2B), coinciding with elevated economic uncertainty and

an increased savings rate (Figure 1.6). In contrast, other proxies have recovered. Figure 2.2C indicates that

durable consumption, often a procyclical indicator, has exceeded its pre-pandemic peak. As noted in the

November 2020 issue of the DERA Economic and Risk Outlook, this jump may be related to households

making up for missed consumption opportunities following the initial COVID-19-induced lockdowns, a

decline in debt-service payments as households have capitalized on low interest rates, or households using

low interest rates to finance durable purchases. Finally, Figure 2.2D documents that business expectations

of future revenue growth have recovered but remain below the levels seen at the height of the economic

expansion in 2018 and 2019.

DERA ECONOMIC AND RISK OUTLOOK | 5

Monetary Policy and Interest Rates

Key Takeaway: Market participants expect the federal funds rate to remain at its zero

lower bound through 2022, and interest rates have fallen more broadly. Following

unprecedented monetary stimulus and a broader economic and financial market recovery,

inflation expectations have returned to the Federal Reserve’s (Fed) 2% inflation target.

As the COVID-19 pandemic unfolded, the Fed

lowered the federal funds rate to a target range of

0–0.25% by March 15, 2020. Figure 2.3 plots the

recent path of the federal funds rate, along with the

expected federal funds rate as implied in futures

market prices. Futures traders expect the federal

funds rate to stay at its zero lower bound through

2022, as the economy recovers from the COVID19 recession.

At the height of COVID-19-induced financial market distress in March, the Fed also announced

unlimited purchases of Treasuries and agency mortgage-backed securities (MBS). These largescale asset purchases coincided with the formation of numerous liquidity and lending facilities.

The November 2020 issue of the DERA Economic and Risk Outlook described these programs

in depth and compared the Fed’s COVID-19 response to its response during the Great Recession.

6 | U.S. SECURITIES AND EXCHANGE COMMISSION

Figure 2.4 summarizes the Fed’s

recent balance sheet actions by

plotting the path of total Fed

assets during the pandemic

(blue line), as well as the asset

classes that constitute the

largest share of Fed assets in

crisis response. From March

4, 2020, through January 20,

2021, total Fed assets increased

over $3 trillion to more than

$7.4 trillion, about a 75% gain.

The bulk of this rise, consisting mostly of Treasury purchases (purple line), central bank liquidity

swaps (red line), and MBS purchases (gold line), occurred in the immediate aftermath of COVID19-induced financial market distress.

During 2020, inflation plummeted with COVID-19-induced economic distress. Figure 2.5A

shows the annual inflation rate fell to 1% in April 2020. Inflation has since rebounded but

remains below the Fed’s 2% inflation target. Figure 2.5B plots inflation expectations over the

next 5 and 10 years from a given point in time, computed from Treasury nominal and inflationprotected securities. The graph documents that with the onset of the pandemic, inflation

expectations sank; in April 2020, market participants had expected an average annual inflation

rate below 1% over the following 5 years. Since then, with expectations of sustained low interest

rates, Fed announcements of a 2% average inflation target, and possibly expectations of a

broader economic recovery, the expected average annual inflation rate (as of January 28, 2021)

has reached the Fed’s 2% target.

DERA ECONOMIC AND RISK OUTLOOK | 7

The Fed’s sizable monetary stimulus and moderate inflation expectations, coupled with perhaps

an elevated demand for U.S. Treasury securities, collectively presage low U.S. Treasury interest

rates. Figure 2.6A plots the current yield curve for U.S. Treasury securities (blue line) versus its

average over the past 10 years (red line) by maturity horizon. Not only are rates historically

low at the short end of the yield curve (e.g., for short-term securities), but they are also low

for longer maturities. Long-term yields comprise the current short-term rate plus the sum of

market participants’ expectations of future interest rate changes, as well as a term premium (the

additional interest that investors demand in exchange for being locked into a longer term bond

rather than just continuously investing in short-term bonds). The low long-term yields suggest

that the term premium and investors’ expectations of future interest rate increases are low.

Interest rates on other assets have also experienced large declines in response to current

conditions. Indeed, Figures 2.6B and 2.6C show a large drop in Baa corporate bond yields and

the 30-year mortgage rate since the onset of the COVID-19 recession, as well as tightening

spreads relative to Treasuries. The broad-based decline in U.S. interest rates has also coincided

with a decrease in the value of the U.S. dollar. Figure 2.6D plots a trade-weighted dollar index

and shows that the dollar’s value increased about 6% from January to March 2020 before

declining 9% through January 15, 2021.

8 | U.S. SECURITIES AND EXCHANGE COMMISSION

Financial Market Signals

Key Takeaway: Financial market risk proxies spiked in March 2020 with COVID-19induced financial market distress but have recently fallen to near pre-pandemic levels.

Expected debt default probabilities have also fallen, but default risk in hard-hit sectors

remains slightly elevated.

With the onset of the COVID-19 recession,

financial risk proxies spiked. Figure 2.7

plots the corporate default spread (Baa - Aaa

corporate bond yields; panel A), the VIX

equity market volatility index (panel B),

and the St. Louis Fed Financial Stress Index

that aggregates several financial market

stress proxies into a single index (panel C).

All of these indices spiked at the height of

the COVID-19-induced financial market

distress in March 2020. Then, as financial

conditions eased and the Federal Government

implemented unprecedented monetary and

fiscal stimulus, all three risk proxies fell.

Currently, the proxies plotted in Figure 2.7

are near or below their pre-pandemic levels, in

line with moderate credit conditions.

To gauge default risk across sectors, Figure 2.8 plots the change in prices for credit default swaps

(CDS) from January 1, 2020, by category. CDS prices, often referred to as spreads and quoted

in basis points, track the cost to insure an entity’s debt against a future credit event. Thus, a CDS

spread of 200 basis points indicates that the cost to insure $100 million of debt would cost $2

million per year (100 * 0.02). Broadly, rising CDS spreads signal increased expectations in the

probability of default.

While CDS spreads increased drastically in April 2020 across a wide range of economic sectors,

the magnitude of these changes varied across the categories listed in Figure 2.8. Since then,

CDS spreads have slowly fallen. Yet data as of January 18, 2021, indicate that several categories

in Figure 2.8 have CDS spreads slightly above their January 2020 levels and hence elevated

expected default probabilities (red lines). These economic sectors include those whose future

revenue streams are most threatened by the economic fallout from the COVID-19 recession.

Indeed, the most affected debt instruments include consumer cyclicals (travel, tourism, etc.),

emerging markets and developing sovereigns, industrials, oil and gas companies, and U.S. states,

counties, and cities. For further information, see the Research Spotlight, “CDS Pricing and Credit

Events in 2020.”

DERA ECONOMIC AND RISK OUTLOOK | 9

Data Sources: Figure 2.1: BEA, retrieved from FRED (ID: GDPC1); and MarketWatch. Figure 2.2A: BLS, retrieved from FRED (ID:

PAYEMS). Figure 2.2B: University of Michigan, retrieved from FRED (ID: UMCSENT). Figure 2.2C: BEA, retrieved from FRED (ID:

PCEDG). Figure 2.2D: Federal Reserve Bank of Atlanta, retrieved from FRED (ID: ATLSBUSRGEP). Figure 2.3: Federal Reserve

Board (FRB) (ID: FEDFUNDS) and Datastream. Figure 2.4: FRB, retrieved from FRED (IDs: WALCL, TREAST, WSHOMCB,

WORAL, SWPT). Figure 2.5: U.S. Treasury, retrieved from FRED (IDs: PCEPILFE, T5YIE, T10YIE). Figure 2.6A: U.S. Treasury and

FRB, retrieved from FRED (IDs: DGS1MO, DGS3MO, DGS6MO, DGS1, DGS2, DGS3, DGS5, DGS7, DGS10). Figure 2.6B: Moody’s,

retrieved from Wharton Research Data Services (WRDS) and FRB, retrieved from FRED (ID: DGS10). Figure 2.6C: Freddie Mac

and FRB, retrieved from FRED (IDs: MORTGAGE30US, DGS10). Figure 2.6D: FRB, retrieved from FRED (ID: DTWEXBGS). Figure

2.7A: Moody’s, retrieved from WRDS. Figure 2.7B: Chicago Board Options Exchange, retrieved from FRED (ID: VIXCLS). Figure

2.7C: Federal Reserve Bank of St. Louis, retrieved from FRED (ID: STLFI2). Figure 2.8: S&P Capital.

10 | U.S. SECURITIES AND EXCHANGE COMMISSION

Market Segments

The U.S. Securities and Exchange Commission’s mission is to protect investors, maintain

fair, orderly, and efficient markets, and facilitate capital formation. Below we examine the

underpinnings of financial markets through the lens of these three mission areas and study

(1) markets; (2) investors; and (3) borrowers, securities issuers, and other entities that raise

capital. The chart below illustrates the interlinkages between these three segments.

Markets

Key Takeaway: Aggregate equity and bond markets have nearly fully recovered from the

initial COVID-19-induced financial market distress in March 2020.

Figure 3.1 graphs the price change from

January 1, 2020, for the Russell 2000

(an equity index of small cap stocks),

the S&P 500, and the S&P 500 Top 50

(the 50 largest companies in the S&P

500). The plot shows that equity indices

plunged following the initial COVID-19

financial market shock, with the Russell

2000 falling nearly 40%. The outsized

decline in the Russell 2000 may have

been due to the often more volatile

income and revenue streams of smaller

companies. Conversely, the S&P 500 Top 50 outperformed. This outperformance may have been

related to the strong financial position of large firms in the lead-up to the pandemic, as well as the

sectoral makeup of firms in the S&P 500 Top 50. Indeed, as noted in the July 2020 issue of the

DERA Economic and Risk Outlook, many of the largest firms that make up the S&P 500 Top

50 have business models well suited to cope with recent changes in consumer and firm behavior,

such as those induced by COVID-19 health and physical distancing protocols. As economic and

financial stress eased starting in April, all three indices moved upwards in parallel, highlighting

the broad-based recovery in financial markets. Recently, beginning in October 2020, returns on

the Russell 2000 accelerated so that the total returns over the plotted period are similar across all

three indices.

DERA ECONOMIC AND RISK OUTLOOK | 11

For fixed income markets, Figure 3.2 displays

total bond market returns and yields by credit

rating. Panel A shows total bond returns since

2020, while panel B plots bond yields. Because

of a decline in economic activity due to the

COVID-19 slowdown and thus increasing

credit risk concerns and default probabilities,

total returns on the lower rated B and CCC

bonds fell between 15% and 25% from

January to mid-March 2020 (Figure 3.2A).

These credit risk concerns likely outweighed

a broader decline in the risk-free interest rate

(e.g., U.S. Treasuries). Indeed, the poor returns

for lower rated securities through March

coincided with a spike in yields (Figure 3.2B)

that began to abate in April 2020. Since then,

risk-free interest rates have fallen (Figures

2.3 and 2.6), and bond market conditions have eased considerably. Hence, yields across rating

categories have returned to or fallen below their pre-pandemic levels (Figure 3.2B), as bond return

indices have marched upwards (Figure 3.2A).

Mutual Fund and ETF Investors

Key Takeaway: With COVID-19-induced financial market volatility in March 2020, mutual

fund and exchange-traded fund (ETF) investors increasingly moved assets away from

bond and equity market investments. Then, as credit conditions eased, investments

returned, particularly in taxable bond funds.

Figure 3.3 presents weekly net fund flows into select classes of mutual funds and ETFs from

January 1, 2020, to January 13, 2021. Before the COVID-19 pandemic, there were substantial

fund inflows into taxable and municipal bond funds, outflows from domestic equity funds, and

slight inflows into commodity funds. Then, as the COVID-19 pandemic unfolded and the corresponding economic slowdown became imminent, investors, in net, redeemed assets from both

bond and domestic equity markets.

12 | U.S. SECURITIES AND EXCHANGE COMMISSION

Figure Notes: Taxable bonds include, for example, corporate bonds. ETFs sell large blocks of shares to, and redeem them only in

large blocks from, authorized participants, who may transact on their own behalf or act as agent for others, while individual ETF

shares trade on the secondary market.

Net withdrawals from equity funds began in January 2020 and continued following the onset of

the COVID-19 pandemic. Outflows from equity funds may be related to increased direct investment activity by retail investors in equities. In contrast, taxable bond funds experienced sizable

inflows until late February 2020. Then, investors withdrew nearly $300 billion from taxable bond

funds, as default probabilities increased for lower rated bonds and as investors may have sought

to increase their cash positions. Investors’ preference to move assets away from this market may

have resulted in their selling bonds held directly. Outflows may have also indirectly prompted

funds to sell assets in response to redemption requests. The outflows, however, reversed beginning in April, as credit market stress attenuated and as the Fed, in conjunction with the Treasury,

announced the establishment of corporate bond liquidity facilities. Indeed, net fund flows into

taxable bond funds increased by over $400 billion from mid-April to October 2020. A similar,

though muted, trend occurred in municipal bond funds.

DERA ECONOMIC AND RISK OUTLOOK | 13

Borrowers, Securities Issuers, and Capital Formation

Key Takeaway: Capital market activity accelerated in 2020, as more firms entered public

markets and bond issuance increased. Aggregate firm debt-service ratios have also risen

but are in line with historical levels.

Investor interest in SPACs jumped in 2020

(Figure 3.4). In 2020 through SPACs, firms

raised $70 billion in 227 deals, up from $11

billion in 2019. Activity in the traditional IPO

market also expanded in 2020, with 189 deals

worth $71 billion, the largest dollar issuance

since 2014.

In debt markets, non-financial businesses

increased borrowing in 2020 with the onset of

the COVID-19 recession (Figure 3.5A). As noted in the November 2020 issue of the DERA Economic and Risk Outlook, firms may have increased borrowing to capitalize on low interest rates

(Figure 2.6), to accumulate cash in the face of COVID-19-induced economic uncertainty (Figure

1.6), or to prepare for future investments. More specifically, Figure 3.5A shows that year-over-year

(YoY) debt growth for non-financial businesses increased to about 10% in 2020Q2, up from a

range of 5–7.5% from 2015 to 2019. In marked contrast, household debt growth changed little

with the onset of the COVID-19 recession.

14 | U.S. SECURITIES AND EXCHANGE COMMISSION

Figure 3.5B further examines non-financial corporate bond issuance by credit rating. Firms across

all ratings categories issued large amounts of bonds in 2020Q2. Since then, issuance has declined

to normal historical levels but remains slightly elevated for BBB-rated firms.

To gauge the burden of debt payments across

sectors, Figure 3.6 plots debt-service ratio

proxies for the Federal Government (panel

A), public firms (panel B), and households

(panel C). First, as discussed in the November

2020 issue of the DERA Economic and Risk

Outlook, Federal Government interest payments relative to GDP (Figure 3.6A) remain in

line with recent historical values, despite the

passage of substantial fiscal stimulus to combat

the COVID-19 recession. These low Federal

Government debt-service payments are a result

of historically low Treasury rates (Figure 2.6A).

Next, Figure 3.6B plots the debt-service burden

for public firms in aggregate, proxied by interest expense relative to earnings before interest

and taxes (EBIT) over the last 12 months.

While this debt-service ratio has increased as business debt issuance has accelerated (Figure 3.5), it

remains in line with historical values as corporate interest rates have fallen (Figure 2.6B). Yet there

is heterogeneity in debt burdens across sectors (Figure 2.8 in this report and DERA Economic and

Risk Outlook, November 2020), meaning that debt payments are more onerous for some firms

compared to others.

Finally, Figure 3.6C plots the aggregate household debt-service ratio, measured as debt-service

payments relative to disposable income. With mortgage and other interest rates falling to historical lows (Figure 2.6), many households have refinanced their mortgages and perhaps other debt.

Thus, debt-service payments have plummeted. Indeed, data as of 2020Q3 indicate that household

debt-service payments account for just 9% of household disposable income.

Data Sources: Figure 3.1: Datastream. Figure 3.2: Ice Data Indices, LLC, retrieved from FRED (IDs: BAMLCC0A1AAATRIV,

BAMLCC0A3ATRIV, BAMLCC0A4BBBTRIV, BAMLHYH0A1BBTRIV, BAMLHYH0A2BTRIV, BAMLHYH0A3CMTRIV,

BAMLC0A1CAAAEY, BAMLC0A3CAEY, BAMLC0A4CBBBEY, BAMLH0A1HYBBEY, BAMLH0A2HYBEY, BAMLH0A3HYCEY).

Figure 3.3: Datastream. Figure 3.4: Capital IQ. Figure 3.5A: Federal Reserve Flow of Funds, retrieved from FRED (IDs:

NCBDBIQ027S, NCBLL, NNBLL, HMLBSHNO). Figure 3.5B: Capital IQ. Figure 3.6A: BEA, retrieved from FRED (IDs:

A091RC1Q027SBEA, GDP). Figure 3.6B: Datastream. Figure 3.6C: FRB, retrieved from FRED (ID: TDSP).

DERA ECONOMIC AND RISK OUTLOOK | 15

Spotlight

CDS Pricing and Credit Events in 2020

Jovan Stojkovic, Anne Yang (Division of Economic and Risk Analysis), and

David Metzman (Division of Trading and Markets)

Overview and Key Highlights

The COVID-19 pandemic has caused millions of deaths, as well as societal and economic disruption

worldwide.1 The impacts of the COVID-19 pandemic continue to be observed in credit markets and, in

particular, the credit default swaps (CDS) market. This analysis compares the impact of the COVID-19

pandemic on the CDS market across several relevant reference entity types—corporate, sovereign, and

U.S. municipal CDS, and CDS indices referencing these types of entities, as well as, particular credit

events that occurred during the pandemic. These are the key takeaways:

• Although CDS prices across the board increased and peaked in late March and early April

2020, when single name CDS prices doubled and CDS index prices more than tripled

compared to the beginning of the year, no major market disruptions in terms of default

contagions have been observed. At the end of 2020, while prices in some sectors had

remained slightly elevated, the CDS market overall continues to function as a valuable tool

for hedging.

• In 2020, credit events triggered 23 CDS contracts, resulting in 19 CDS auctions. The

number of credit events is almost double compared to previous years, and they were more

concentrated in particular sectors, including oil and gas, consumer cyclical, and consumer

noncyclical. This concentration, as well as market uncertainty, likely resulted in lower average

recovery rates of 22.6%. In comparison, in 2009 during the Global Financial Crisis (GFC),

there was a record high number of 45 CDS auctions, but they were in sectors across the

broader economy, with an average recovery rate of 33.8%.

• There were four CDS credit events in 2020 in the sovereign CDS market, which was the

highest number since 2005, but only half of these credit events could be directly linked to the

economic impact of the COVID-19 pandemic. By contrast, the other half of sovereign credit

events were due to unique crises that began before the pandemic.

• CDS that reference U.S. municipal debt saw an increase in trading and prices during 2020.

Although there were no CDS credit events, price levels are likely to remain slightly elevated in

the future, as municipalities continue to be impacted by increased health and unemployment

costs and lower tax revenue.

1

A WHO timeline of its COVID-19 pandemic response is available at: (link).

DERA ECONOMIC AND RISK OUTLOOK | 17

1 Introduction: CDS Market

CDS are financial derivative contracts that are almost exclusively traded over the counter (OTC) by

institutional investors. A CDS contract typically provides the CDS buyer protection from loss from a credit

event on debt issued by the entity referenced in the CDS contract. A CDS contract can also protect the buyer

against the bankruptcy, insolvency, receivership, or liquidation of the issuer of such debt. The referenced

entity may be a corporate, sovereign, or municipal entity, or an index of entities or obligations of entities.2 In

return for receiving credit protection, the CDS buyer pays the CDS seller a “CDS spread.” A CDS spread is a

yearly premium paid in quarterly coupons. After the International Swaps and Derivatives Association (ISDA)

adopted protocols in 2009, the CDS market began using standardized coupons and an upfront payment

that nets out the difference of future CDS spread payments.3 The CDS buyer or seller exchanges upfront

initial payments to net out the differences between the CDS spread used in a particular transaction and the

standardized, pre-set coupon rates. This standardization allows CDS contracts to be uniform, permitting

traders to net future cash flows almost perfectly. Buying a CDS contract is generally the economic equivalent of

being short a bond, and, likewise, selling a CDS contract is generally the equivalent of being long a bond with

the same coupon rates.4 A payment obligation under the CDS is typically triggered when there is a credit event

that occurs for the reference entity, or issuer, referenced in the CDS. In this respect, CDS contracts are often

directly related to the bonds of the reference entities.

Central clearing removed a significant amount of counterparty credit risk by centralizing that risk with the

central clearing counterparties (CCPs). A Financial Stability Board (FSB) analysis of global derivatives markets

shows that since the mid-2000s, there has been a significant increase in central clearing of OTC derivatives and

that such growth was observed for credit derivatives where more than 60% of CDS indices and 40% of single

name CDS were cleared at the end of 2017.5 In its “Weekly Swaps Report,” the Commodity Futures Trading

Commission (CFTC) noted that clearing rates for CDS indices had increased to 74% by the end of 2020.6

In the 2020 market shock that resulted from the COVID-19 pandemic, the capital held by CCPs was not

impacted by the higher number of credit events or by the lower recovery rates. Significant intraday margin calls

across market participants did not require CCP members to provide additional capital to CCPs. This market

shock could have created default contagions through exposures of CDS issuers, as observed during the GFC.

However, thus far no such issues or contagions have been observed in the CDS market during the COVID-19

pandemic. Accordingly, both single name CDS and CDS indices continue to be valuable hedging tools.7

2 A CDS index is an index covering a specific region, sector, or investment rating providing proportional credit risk protection for the

index buyer in case one or more of the index components default, e.g., a CDS buyer with a $100 million notional index with 100

reference entities would receive from the CDS seller, at most, $2 million if two of the reference entities default.

3 ISDA “small bang protocol”: (link); ISDA “big bang protocol”: (link).

4 The coupon payments are standardized and fixed. Accordingly, when a CDS contract is trading below the coupon rate, the CDS

buyer receives an upfront payment to gross it up for the higher coupon payments it will be required to make during the life of the

contract. When a CDS contract is trading above the coupon rate, the CDS buyer would pay an upfront payment to gross up the seller

for the lower coupon payments the buyer will be required to make during the life of the contract. Standard coupon rates for CDS

North American contracts are 100 basis points (bps) and 500bps, while for European contracts they are 25bps, 100bps, 500bps or

1,000bps. Both have coupon payment dates of the 20th of each of March, June, September and December. ISDA Standard North

American contract specifications, available at: (link); ISDA Standard European contract specifications, available at: (link).

5 Figure C.4 of “Incentives to centrally clear over-the-counter (OTC) derivatives” (link).

6 CFTC Weekly Swaps Report (link).

7 SEC Staff report, “U.S. Credit Markets Interconnectedness and the Effects of the COVID-19 Economic Shock” (link).

18 | U.S. SECURITIES AND EXCHANGE COMMISSION

2 Impact on Pricing

To understand the impact of the COVID-19 pandemic on the broader CDS market, this analysis

compares normalized indices of median CDS prices from January to December 2020, discussed in the

following sections:

Section 2.1, Impact on CDS market and indices: Five global CDS indices: North American Investment

Grade (“NA.IG”); North American High Yield (“NA.HY”); and North American High Volatility

(“NA.Hvol”) indices; and European investment grade (“iTraxx”) and high-yield (“Crossover”) indices,

(Exhibit 4.1, top chart) and the impact on market liquidity (Exhibit 4.1, bottom chart).

Section 2.2, Impact on single name corporate CDS: Four affected sectors: consumer cyclical, consumer

noncyclical, oil and gas, and other sectors (Exhibit 4.2).

Section 2.3, Impact on single name sovereign and municipal CDS: sovereign CDS split into advanced

economies (AEs), U.S. municipal (U.S. Muni), and emerging market economies (EMEs) (Exhibit

4.3, top chart) and price movement of CDS referencing sovereign entities that had a credit event—

Argentina, Ecuador, Lebanon, and Zambia (Exhibit 4.3, bottom chart).

DERA ECONOMIC AND RISK OUTLOOK | 19

2.1 Impact on CDS Market

and Indices

In the first quarter of 2020, the combination

of the COVID-19 pandemic and the oil-price

war led to increased economic uncertainty and

record CDS market activity.8 As CDS indices are

often regarded as the most liquid and effective

instrument to hedge credit risk, CDS prices had

a surge of three to four fold, before they dropped

back to close to normal levels starting in the

late fall of 2020 (Exhibit 4.1, top chart). These

economic shocks impacted certain reference

entities especially hard, particularly in the oil and

gas and consumer cyclical sectors. A survey of

172 market participants around the world found

that the wider swap market experienced a drop

in liquidity earlier in 2020 and that the CDS

market was particularly impacted. The situation

improved after the Federal Reserve (Fed) and

the European Central Bank (ECB) announced

that they would intervene in the markets.9 The

relative bid-offer spread scaled by the mid-CDS

price, which is used as an indicator for liquidity,

confirms this temporary drop in liquidity in

March/April, which was more pronounced in the

higher normalized relative CDS index bid-offer

spread (Exhibit 4.1 bottom chart).

2.2 Impact on Single Name

Corporate CDS

Oil and Gas

The oil and gas sector was impacted by two

overlapping shocks. In particular, the early phases

of the COVID-19 pandemic occurred while oil

and gas firms were already suffering from

8 The Washington Post describes “the oil-price war” as, “A petroleum price war [that] exploded in March after the dramatic

collapse of an alliance between the OPEC cartel and Russia, a pact that had underpinned world oil markets for three years. In

the days that followed, the price of oil plunged more than 50%, sending shockwaves through a global economy reeling from

the fallout of the coronavirus pandemic.” Washington Post, “Why the OPEC-Russia Blowup Sparked All-Out Oil Price War”

(link).

9 “The Impact of COVID-19 and Government Intervention on Swaps Market Liquidity” (link).

20 | U.S. SECURITIES AND EXCHANGE COMMISSION

lower commodity prices. CDS referencing oil

and gas companies accounted for 6 out of 19

corporate CDS credit events, or almost one-third,

since April 2020.10 CDS prices on a number of

oil and gas companies drastically increased again

starting in late September 2020 and some oil

and gas companies were trading close to all-time

highs in the fall of 2020. Not surprisingly, in

the broader context, CDS prices on EMEs that

are significant exporters of raw commodities,

particularly oil and gas, increased in the first

months of the pandemic. The press and analysts

reported on this trend for the Gulf states, but

none had a credit event in 2020.11

Consumer Cyclical/Consumer

Noncyclical

The consumer cyclical sector refers to companies

relying heavily on the business cycle and

economic conditions. Consumer cyclical firms

include industries such as automotive, travel, housing, entertainment, and retail. Four out of 19

corporate CDS triggers since the onset of the COVID-19 pandemic involved the debt of companies

in the consumer cyclical sector.12 CDS written on consumer noncyclical companies also triggered

credit events.13

10 This figure is calculated based on staff observations of credit events listed on the CDS Determination Committee website

(link) and Credit Fixing website (link).

11 Reuters, “Credit risk rises for Gulf crude exporters on virus fears” (link).

12 Source: S&P Capital CDS pricing.

13 Sector categorizations do change from time to time.

DERA ECONOMIC AND RISK OUTLOOK | 21

2.3 Impact on single Name Sovereign and Municipal CDS

Advanced and emerging market economies have been impacted differently by the pandemic, and this

is reflected in their different CDS price movements. The impact of the COVID-19 pandemic on AEs’

credit markets seemed to be transient, especially in the near term. Although these economies issued

large amounts of debt to protect their financial systems, the demand for less risky assets, predominantly

government bonds, lowered their borrowing costs. The initial uncertainty caused by the COVID-19

pandemic created a flight to safety, attracting investors to AEs’ debt. In the immediate term, at the

beginning of 2020 in the infancy of the COVID-19 pandemic, AEs had minimum CDS price increases,

but by late March and into April of 2020, the pricing on CDS issued on AEs more than doubled. This

elevated level was relatively brief, as prices started to revert and, by the end of the summer, almost

totally recovered. At the end of September 2020, the median price of a CDS from AEs was trading at

1% to 5% higher compared to the beginning of the year — in essence, trading at par.14

On the other side of the spectrum, three types of sovereign CDS credit event scenarios developed for

EMEs: (1) EMEs that had ongoing problems with expected credit events even before the pandemic; (2)

EMEs that were severely impacted by the COVID-19 pandemic and reprioritized their spending; and

(3) EMEs that are significant exporters of raw materials, where CDS prices increased as a result of a

decrease in the demand for raw materials.

Impact on Emerging Market Economies’ CDS

CDS prices referencing debt issued by EMEs experienced significant price volatility, and the economic

effects of the COVID-19 pandemic seem to be nontransient for EMEs. Four EMEs triggered their CDS

in 2020.15 Two credit events were observed in the spring of 2020, and were somewhat expected, as

the two countries suffered from social economic issues and a shortage of hard currencies. Both of these

credit events were a consequence of deep economic problems and political instability.16 A third default

was the result of not treating all debt with the same seniority equally. CDS pricing data indicates that

only one credit event appeared to be very clearly and directly related to the economic impact of the

COVID-19 pandemic. In this instance, that country’s government decided to use funds to relieve some

of the effects of the COVID-19 pandemic.17 Another default is a result of not treating all debt with the

same seniority equally.18

14 There were instances when the relative order changed. For example, in early summer, U.S. sovereign CDS were, for the first

time, priced higher than CDS prices on debt issued by France, but these minor price changes did not have a great impact

and were transient.

15 Staff reviewed CDS credit events listed on the CDS Determination Committee website (link) and Credit Fixing website (link).

16 Congressional Research Service, “Argentina’s Economic Crisis and Default” (link) and facts presented to the DC with regard

to Argentina (link).

17 Facts presented to the DC with regard to Ecuador (link).

18 Facts presented to the DC with regard to Zambia (link).

22 | U.S. SECURITIES AND EXCHANGE COMMISSION

The price dynamics in the period prior to CDS

triggering show the difference in the default

events. Exhibit 4.3 shows a price index of the

four sovereign CDS prices 50 days before the

Credit Derivatives Determination Committee

(DC) determined their auction dates.19 One

month before the default, the CDS price of one

sovereign drastically increases — it came close

to tripling compared to initial levels (Exhibit

4.3, bottom chart). This price jump in CDS

referencing this sovereign reflected news that the

sovereign’s government planned to suddenly shift

funds to focus on the pandemic, instead of paying

foreign bondholders.20 This sudden price increase

is likely indicative of institutional investors being

surprised by the government’s decision. Another

sovereign’s default, while likely related to the

pandemic, did not have a significant impact on

the market because of the technical nature of

the credit event and the small CDS outstanding

notional. This sovereign’s government may have

given preference to certain government debt, as

compared to other debt holders.21

In the fall of 2020, CDS referencing South

and Central American sovereigns continued

to increase as CDS prices increased by 35%.

Similar increases were also observed in other

geographical regions including CDS referencing

African and Eastern European sovereigns; prices

on those CDS contracts approximately increased

by more than 15% and 30%, respectively.

19 The DC is a committee made up of relevant market participants that, among other things, determines credit events (link).

20 Bloomberg, “Ecuador Default Odds Surge as Virus Prompts Calls for Moratorium” (link).

21 Financial Times, “The ‘blood, sweat and tears’ behind Zambia’s default,”(“Hours before the default, bond investors rejected a

request for a standstill over concerns that Mr Lungu’s [President of Zambia] government was not coming clean on Chinese

debts worth $3bn. The government said that bondholders were getting the same treatment as Chinese and other creditors

that it had already defaulted on.”) (link); Facts presented to the DC with regard to Zambia (link).

DERA ECONOMIC AND RISK OUTLOOK | 23

Although larger sovereigns are unlikely to default in the near or medium term, as the press reported,

the relatively high CDS price is likely indicative of future credit concerns.22 Similar, prominent increases

were not observed in Asia.

Impact on U.S. Municipal CDS

At the start of the COVID-19 crisis, there was little to no impact on CDS contracts that reference

U.S. municipal entities. This suggests that investors did not immediately realize the impacts on the

costs and future needs of the U.S. municipalities and local governments. During the period prior to

the COVID-19 pandemic, the price dynamics of CDS referencing U.S. municipals were similar and

correlated to investment grade sovereigns, Exhibit 4.3, top chart.

Due to COVID-19-related impacts on increased health costs, lower tax revenues, and large

unemployment benefits paid out by local and state governments, U.S. municipal CDS prices peaked

in mid-May, at a slightly later point in time, and were trading at three times their January levels. These

higher price levels occurred in CDS referencing larger municipalities, such as Chicago and New York

City, and the states of Illinois and California. Such spikes in CDS pricing generally reflect the surges of

COVID-19 cases in these states and localities. Beginning in May 2020, the prices of CDS referencing

these municipalities slowly and steadily decreased, but never again reached the lower initial preCOVID-19 pandemic levels. In late summer and early fall of 2020, the trend changed and municipal

CDS prices began to hold steady at higher levels, with some of them slightly increasing.

3 Impact on Recovery Rates

During the peak economic impact of the COVID-19 pandemic in March and April 2020, large

movements in CDS prices were observed across different sectors and indices. The price changes

reflected a change in value and expected payments, but because of a lag in the timing of CDS triggers,

the credit event dates and hence potential CDS auctions were delayed. For example, there is normally a

grace period of 30 days, or more, following a failure to make an interest payment before a credit event

can be declared, thereby triggering the CDS. If there is a potential CDS trigger resulting from a credit

event, under a CDS contract, a holder of the CDS can submit a request to the DC to decide whether

there has been a credit event triggering payments under the CDS contract. The DC then decides

whether the CDS have been triggered. The three most common credit events triggering a payment

under CDS are (1) bankruptcy or insolvency of the issuer, (2) payment defaults (which usually include

a grace period for bond interest payments), and (3) debt restructuring. It there is a CDS credit event, the

buyer of the CDS is normally paid par for the obligation, minus the current value of the defaulted debt,

which is determined by an auction — the auction recovery rate.

22 Bloomberg, “Year of Pain Sets Stage for 2021’s Top 10 Emerging-Market Themes” (link).

24 | U.S. SECURITIES AND EXCHANGE COMMISSION

Market stress was evident in the number of

CDS contracts that had a credit event in 2020,

amounting to 23 contracts in total. CDS on

high-risk debt were the first to be impacted. This

number included 4 sovereign debt issuers, out of

which 3 held auctions (see shaded lines in Exhibit

4.4) and 19 corporate debt issuers, out of which

16 held auctions (bold in Exhibit 4.4). There were

only 12 CDS auctions in 2019 and 6 auctions

in 2018 across all corporate entities. Prior to the

COVID-19 pandemic, Venezuela was the last

sovereign to have a credit event, which was in

2017, with a recovery rate of 24.5%.23 While the

number of CDS contracts that had a credit event

was larger in 2020 relative to previous years,

that number is still relatively small compared to

the GFC. For example, in 2009 there were 45

CDS auctions, which resulted from defaults by

43 corporate and 2 sovereign issuers. In addition,

the observed recovery rates in 2020 are lower

compared to the previous years. In 2019 and

2018, the average recovery rates for corporates

were 46% and 57%, respectively. The dashed

line in Exhibit 4.4 denotes the average recovery

rate in 2020.24

CDS credit events in 2020 were clustered in particular sectors. For example, CDS credit events took

place in the oil and gas sector, specifically offshore drilling.25 In addition, brick and mortar focused

retailers were affected. This appears to be directly related to the COVID-19 pandemic, as some

retailers have defaulted with noticeably lower recovery rates, meaning their cheapest-to-deliver bonds

were valued at lower than initially expected recovery rates.26 Meanwhile, other U.S. brick and mortar

retailers were downgraded, resulting in the reshuffling of the investment grade and high-yield indices.

The unusually low recovery rates from CDS auctions of brick and mortar retailers are likely to be even

lower than what investors had initially expected when they entered the CDS contracts. We expect

23 Facts presented to the DC with regard to Venezuela (link) and the auction results (link).

24 According to J.P. Morgan, the default cycle caused by the COVID-19 pandemic in Europe will be less severe than expected

because of monetary and fiscal stimulus (Bloomberg terminal). Recovery rates in these times of crisis have been the lowest

average recovery rates since records began in 2005. These low recovery rates led to record credit derivatives payouts.

(Financial Times article: link).

25 Facts presented to the DC and the auction results with regards to Whiting Petroleum Corp. (link/link), Diamond Offshore

Drilling (link/link), California Resources (link/link), Chesapeake Energy Corp. (link/link), Noble Corp. (link/link), and Ensco

(link), respectively.

26 Facts presented to the DC with regard to J.C. Penney (link) and the auction results (link). Facts presented to the DC with

regard to Neiman Marcus (link) and the auction results (link).

DERA ECONOMIC AND RISK OUTLOOK | 25

that these low recovery rates occurred because defaults clustered in particular industries. For example,

several companies in the retail sector defaulted around the same time, and — examined in relation

to their liquidation value — the real estate of each company may have a lower recovery value as

compared to a scenario where both companies did not default contemporaneously.

4 Conclusion

No major market disruptions have been observed in the CDS market in connection with the

COVID-19 pandemic, and the CDS market continues to function well, as have the CCPs. Single

name CDS and CDS indices overall, with some exceptions, were trading at a slight premium at the

end of 2020, compared to where they were at the beginning of that year. Those trends are expected to

continue into 2021, but the actual outcome will reflect the overall state of the economy, the course of

the COVID-19 pandemic, and the speed of the vaccine rollout. The prices of CDS referencing EMEs

and municipal issuers may remain elevated because of health care costs that are expected to continue

to increase and which may lead to higher government debt levels. The municipal CDS market is small

relative to credit markets, and any credit events that may occur are not expected to lead to broader

market contagion. The markets for single name CDS and CDS indices are not expected to be disrupted

and are expected to continue to function as valuable hedging tools for the wider credit markets.

26 | U.S. SECURITIES AND EXCHANGE COMMISSION

U. S . S E C U R I T I E S A N D E XC H A N G E CO M M I SS I O N