Corporate bonds lost $1trn and there’s more trouble ahead

The worldwide pool of the safest corporate debt has already shrunk by $805 billion so far this year, while the global junk market lost $236 billion, according to data compiled by Bloomberg. That’s the biggest dollar decline since records began over 20 years ago, following a borrowing binge propelled by record-low funding costs.

The slump marked the biggest total return loss since Lehman Brothers’ collapse for high-grade bonds, and the worst performance since the start of the pandemic for junk.

The global credit market remains under pressure from rampant inflation, which will push central banks to boost rates, in turn risking an economic slowdown. Meanwhile, Russia’s invasion of Ukraine increases concerns about Europe’s ability to fulfill its energy needs and further disrupts already struggling supply chains.

“We’ve really got a lot of things we have to contend with,” said April Larusse, head of investment specialists at Insight Investments, which oversees 867 billion pounds ($1.14 trillion). And given that “there can be endless talk and quite little progress” between Russian and Ukrainian negotiators, “it’s probably unwise to put a large directional bet.”

Ukraine outlook
Sceptical NATO allies are evaluating whether Russia’s promise to scale back military operations in Ukraine marks a turning point in the conflict or simply a tactical shift. Hopes for progress in negotiations helped bring spreads in global high-grade debt below levels last seen before Russia’s invasion of Ukraine on Feb. 24. Morgan Stanley’s U.S. and European credit strategy head warned this could prove a blip as focus shifts to central bank hawkishness.

Losses have been coming from all sides, especially in the high-grade market, which is more exposed to the global rise in government bond yields as central banks tighten policy. This is due to their higher duration, bond parlance for price sensitivity to changes in interest rates.

Yields on 10-year U.S. Treasury and German government bonds have surged to their highest levels since 2019 and 2018 respectively. U.S. two-year yields briefly exceeded the 10-year level on Tuesday for the first time since 2019, signaling that rate increases by the Federal Reserve could trigger a recession.

Meanwhile, corporate bonds’ risk premium above supposedly safe debt has also jumped year-to-date. While spreads reversed some of their widening in recent weeks, analysts expect pressure to resume.

In Europe, bonds indicated at a discount to face value now account for two-thirds of the euro high-grade market from about a quarter at the end of 2021, based on data compiled by Bloomberg.

Persisting risks 
Still, what looks cheap now can get even cheaper later, especially as the risks that have driven first-quarter losses look set to persist.

“Twelve-month forward excess return expectations from current levels are historically good,” said Greg Venizelos, a credit strategist at Axa Investment Managers, which oversees 887 billion euros. “This doesn’t mean there is no further downside – it’s a good entry point but could get even better in the weeks ahead. It’s prudent to stay a bit cautious.”

To be sure, sharp price drops have allowed some investors to scoop up what they regard as bargains at spread levels not seen since the start of the coronavirus pandemic.

“We view investment-grade in dollars as a strong buying opportunity, probably the best opportunity in the current environment if we think in terms of risk-adjusted expected returns,” said Eric Vanraes, a portfolio manager at Eric Sturdza Investments, which oversees $1.7 billion.

“The widening of spreads has been amplified by poor liquidity,” Vanraes said. “It will improve when people like us seize the opportunity and become buyers of the asset class.”

Elsewhere in credit markets: 

EMEA
Rabobank and CEZ AS are among 14 issuers bringing 18 tranches in Europe’s primary market on Wednesday, amounting to a minimum of 8.23 billion euros. The Dutch lender is offering an additional tier 1 note, the riskiest type of bank debt, while the Czech gas distributor is set for a benchmark-size sustainability-linked bond.

• Weekly issuance volumes are set to exceed 24.3 billion euros, potentially bringing year-to-date supply above the 500-billion-euro mark
• Payment related to a Swiss franc bond by Russian Railways has not gone through for compliance reasons, according to a filing
• Gold miner Petropavlovsk started talks with advisers for a potential debt restructuring after its lender Gazprombank was added to the list of U.K.-sanctioned entities.

Asia

Asia’s corporate bonds rallied as investors weighed the prospects of a de-escalation in Russia’s war on Ukraine, while three borrowers are offering their dollar notes in the region’s primary market on Wednesday.

• Spreads on the region’s investment-grade notes narrowed at least 2-3bps, credit traders said, which leaves them at the tightest level in more than a month, according to a Bloomberg index
• Greenko Wind Projects Mauritius Ltd. may price its benchmark-size green dollar bond today along with State Grid Europe Development and MISC Capital Two Labuan Ltd.
• Despite the reprieve from the recent bond market rout, some analysts caution that more troubles may await debt securities. Investors should move up in quality in credit as tightening liquidity conditions are going to make refinancing more difficult for marginal companies, according to Paul Lukaszewski, head of corporate debt for Asia Pacific at Abrdn in Singapore

Americas

High-risk companies that tapped the $1.4 trillion U.S. leveraged loan market have been largely insulated from rising short-term rates. Now they’re about to feel the pain.

• Morgan Stanley’s Head of U.S. and European Credit Strategy Srikanth Sankaran said a rally in equity and credit markets on optimism about progress in cease-fire talks between Russia and Ukraine is just a temporary blip
• U.S. bankruptcy courts saw three large filings last week, making March by far the busiest month so far this year for big insolvencies