ewsba.se
Corporate bonds have been relatively resilient amid a global government bond selloff, but the strength may not last.
Bond market volatility, a measure of uncertainty about the direction of bond yields, is spiking. Historically, that has foreshadowed trouble for corporate debt, as nervous retail investors and others pull money from the market.
For now, company profits are strong and higher overall corporate bond yields in part reflect solid economic growth. But, as inflationary pressure builds, the Federal Reserve is boosting rates to slow that growth. Over time, higher rates can hurt the economy and squeeze profits, and corporate bonds are already priced with little margin for error, said Kelly Kowalski, head of investment strategy at MassMutual.
“The longer yields are elevated and volatile, the more restrictive financial conditions become and the more they weigh on economic activity, corporate margins, and credit quality,” Kowalski said.
The result may be that company bonds eventually underperform government debt, which would boost the extra yield relative to Treasuries that companies pay to borrow, a difference known as the spread. JPMorgan Chase & Co. strategists including Nathaniel Rosenbaum estimated this week that US high-grade corporate bond spreads should be about 0.07 percentage point wider than they are now based on historical measures of bond and stock market volatility.
Yields across bond markets have broadly jumped in the last month as oil prices have climbed and inflation fears have risen. Most benchmark US Treasuries now have yields above 5%, with five-year yields climbing above that threshold for the first time since 2007.
Corporate bonds have largely shrugged off these moves. US high-grade spreads were 77 basis points on Thursday, two basis points tighter than their levels at the start of the month. Money managers looking to fund future liabilities, such as pensions and insurers that sell annuities, often buy corporate debt when yields rise, supporting relative performance for company bonds.
“There’s a lot of market experience with times where rates go up in a fairly controlled fashion because the economy is actually good, is doing well. And in those cases, the shocks tend to be fairly short-lived and moderate,” said Robert Tipp, head of global bonds and chief investment strategist at PGIM.
Even so, some investors are preparing for potential weakening. The ICE BofA U.S. Bond Market Option Volatility Estimate Index, known as the MOVE index, surged to about 105 basis points this week, its highest level since March and far above its average of about 80 for the decade.
Those kinds of debt market volatility surges can be a prelude to corporate spreads rising, as in early 2023, when bond yields rose, as did the MOVE index. But the correlation isn’t perfect. And a separate measure of fear in US equity markets, the VIX, hasn’t jumped.
“Yield-oriented investors want higher yields, but they want stable, higher yields, and yields have been anything but stable,” said Tom Murphy, head of investment-grade credit at Columbia Threadneedle Investments.
The cost of protecting a portfolio of North American credits against default using credit derivatives has also edged higher recently, even accounting for changes to the constituents of the index, a sign that investors are getting a bit more antsy about default risk. The CDX Investment Grade Index was around 58 basis points on a roll-adjusted basis on Friday, compared with roughly 55 basis points at the end of August.
Climbing yields are already having an impact on corporate debt sales. US companies sold about $33 billion of bonds this week, falling short of the roughly $40 billion forecast by dealers. Several borrowers paid roughly an extra 6 basis points to investors earlier this week, and order books shrank. At least one issuer stood down on Wednesday.
Heavy investment-grade issuance in August was, in part, spurred by concerns that rates may go higher, with companies pulling forward their borrowing plans. Issuers have now become more cautious after the recent jump in Treasury yields, said Maureen O’Connor, global head of high grade debt syndicate at Wells Fargo.
“The conversation has become more nuanced recently. As 10-year Treasury yields are now comfortably north of 5%, the question has shifted to whether the bond market is oversold. This could be a catalyst for some opportunistic issuers to pause their funding plans,” O’Connor said.
Higher yields typically hit prices on longer duration bonds first, and it often takes time for rising borrowing costs to translate to defaults. If yields stay high, some companies will have trouble refinancing, particularly those that are rated in the lowest-trading CCC tier, as well as companies in private credit and software, strategists including Matthew Mish wrote in a note on Wednesday.
Some strategists and investors think it makes sense to buy higher-quality bonds and cut their credit risk.
“We have to think about ways in which we think these companies are going to be able to mitigate not only energy costs, but also rising interest rate costs,” said Nachu Chockalingam, senior credit portfolio manager at Federated Hermes Ltd.
“They’re having to refinance paper that was 3%, 4%. Now we’re almost double that. So we have to think about how these companies are going to maintain their liquidity and balance sheets in this environment where there is a huge amount of bottom-up pressure that they’re having to face.”
Credit Edge: Magnetar Eyes $600 Billion Stressed Debt
This article was generated from an automated news agency feed without modifications to text.
Catch all the Business News , Market News , Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.