Credit’s Strong Run Stumbles for First Time This Year

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(Bloomberg) — Global corporate bond spreads are on track to turn around in their first month of weakness since late last year, reigniting the debate over the relative value of credit versus other fixed-income classes ahead of the second half of 2024.

Spreads on corporate bonds including junk bonds and investment-grade bonds have widened by about 10 basis points so far in June, from their lowest levels in three years, the Bloomberg index showed. Meanwhile, yield premiums on those bonds as well as high-quality U.S. bonds are rising from levels touched in May that have been seen for less than 1% of the period since the 2008 global financial crisis, the data show.

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While a significant widening of spreads would make credit less attractive compared to Treasuries, strategists at Goldman Sachs Group led by Lotfi Karoui do not expect this to happen. The bank expects US high-quality spreads to end 2024 at 90 basis points and junk spreads at 291, compared to current Bloomberg index levels of 94 basis points and 314 basis points, respectively.

“We are in this pattern of consolidation against the macroeconomic backdrop, which is not too hot and not too cold,” said Neeraj Seth, chief investment officer and head of Asia-Pacific core fixed income at BlackRock in Singapore. This is typically a “good environment” for credit, and while spreads may widen at different junctures, there is still potential for them to tighten over six to nine months, he said.

Investors don't get much money for credit risk, according to abrdn investment director Luke Hickmore. However, he still sees a case for holding corporate debt where spreads could remain around current levels for several more years, similar to the period between 2004 and 2006 when interest rates remained high.

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He noted that “the fundamentals are very good right now” after many companies reduced debt. “With deleveraging, a fairly stable economic outlook, and rising interest rates, you may also get an additional load.”

A drop in US Treasury yields this month on renewed bets that the Fed will cut interest rates at least once this year is partly to blame for the widening of credit spreads, as corporate bonds typically take time to keep up with moves in more liquid government debt.

“Historical spreads struggle to tighten when yields fall, until they stabilize again,” Eric Beinstein and Nathaniel Rosenbaum, strategists at JPMorgan Chase & Co., wrote in a note this month. They added that it is uncertain whether this will cause some investors to back off, as was observed earlier in the month.

Some argue that the problem with corporate credit has more to do with the small rise in returns relative to the risks they face, rather than any clear signs of weak economies or problems with corporate balance sheets.

Noah Wise, a portfolio manager at Allspring Global Investments, says he is taking advantage of the recent rise in high-yield bonds to reduce his exposure to debt. He added that he prefers mortgages offered by US agencies that have AA ratings with spreads in the 50s.

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“There is a historically tight spread for credit risk at this point, so valuations are not attractive,” he noted. “We are in a relatively minor situation.”

So far this year, corporate bonds have outperformed Treasuries. This is expected to continue, as strategists at Goldman Sachs see high-quality, high-yield dollar and euro bonds outperforming government bonds this year.

The bank said in a report issued in June that European junk bonds may generate excess returns of 5% in 2024, while their American counterparts may generate 3.7%, while high-quality European and American securities may achieve 2.7% and 1.5%. 6% respectively with the same scale. .

Benchmarks for US high-yield debt issuers were mixed. Companies showed broad-based deterioration in the first quarter with profit margins falling to their lowest level in three years, although leverage was comfortably below the long-term average, JPMorgan strategists, including Nelson Jantzen, wrote. In a memo dated June 12.

Click here to listen to Arini's Lemssouguer talk about how junk companies come to a dead end.

“In this kind of environment where spreads are very tight, the front end of the curve, which is the shorter-dated bonds, is where I will look into it for transfer.” Asian Bank Equity Securities He added: “At the long end of the curve, given where the spreads are, I would rather take an opportunistic position in Treasuries or futures given the volatility” to take advantage of any lower move in yields.

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Kwong expects the Fed to cut interest rates once or twice this year and three to four times next year, with economies broadly resilient.

“The fundamental picture is deteriorating slightly, and credit spreads are at very tight levels,” warns Gabriel Foa, portfolio manager at Algipress Investments. “This is really a wake-up call,” he added. “We have a few long positions, but overall we have the most cautious stance on credit in the last couple of years.”

For Pauline Crystal, a fund manager at Capstream Capital in Sydney, tight valuations for US dollar-denominated corporate bonds are also a concern. She prefers Australian accreditations where assessments are less stretchy.

“Credit spreads that could narrow another 20 or 30 basis points is something I find hard to believe,” she said. “But if the momentum is very strong and every one of your peers is constantly investing in credit, you can't just hold cash.”

Week in review

• Some money managers who buy junk bonds have been putting their money into investment-grade bonds instead, because yields can be almost as high now.
• Private equity investors demand their payouts. The risky approach to meeting their demands – i.e. recapitalizing profits – is to make record numbers and gain more popularity.
• Bank of America's Dan Meade expects U.S. blue-chip bond market activity to slow through the end of this year, after borrowers piled on debt in the first half, driven by attractive yields now and avoiding election volatility later.
• The US Supreme Court upheld a 2017 tax on the foreign profits of American-owned companies, rejecting an appeal that could have saved the companies hundreds of billions of dollars.
• President Emmanuel Macron's surprise election call highlighted France's importance in European credit markets.
• Chinese companies join this year's largest round of issuance of Japanese currency notes by borrowers in the country since 1986 in a still small but growing market.
• Investors in the $1.3 trillion collateralized loan obligations market expect to benefit from Norinchukin Bank's pain, as the Japanese whale looks to unload some sovereign bonds and rotate its investments into other markets.
• Enel Finance International tapped the US investment grade bond market for the first time after missing emissions targets and boosting bond coupons.
• Canadian energy pipeline company Wolf Midstream is preparing to sell C$600 million ($438 million) of junk bonds.
• Home Depot Inc. sold $10 billion worth of bonds in the US investment market to help finance its acquisition of construction products distributor SRS Distribution Inc.
• Hertz Global Holdings Inc. The volume of its junk bond sale increased by a third to $1 billion, as the car rental company works to strengthen its balance sheet after a mistake in its electric car fleet.
• After a two-year absence from the asset-backed securities market, Carlyle Aviation Partners is back selling bonds backed by commercial aircraft, a market where issuance could continue to rise as new aircraft sales come under pressure.
• Collateralized loan obligation managers, the largest investors in leveraged loans, have long taken a back seat role when borrowers get into trouble. This is starting to change.

It moves

• Christopher Horn, a widely recognized industry leader in structuring securitization transactions, has joined Cadwalader, Wickersham & Taft as a partner in the firm's New York office.
• San Francisco-based Community Investment Management has appointed Ravi Vukadala as regional head of its India operations, just weeks before the country enters the key global bond index.

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