Corporate bond markets are shrugging off global concerns

Financial markets are full of convenient adages that work sometimes but not always, or are generally true but flawed when applied to a specific situation.

One is that stock pickers are bullish and bond investors are bearish, making the bond market a better predictor of future trouble.

When you buy shares of a company, you are (simplifying a bit) betting on positive results for the company that will increase its value. Ergo, optimism.

When you lend money to a company, you usually bet on a single outcome; that the company will return the money. The main thing that threatens you with getting your money back is a company that is doing very poorly. That becomes the focus of attention for bond investors. Ergo, pessimism.

Such pessimism can be useful to the rest of us. The bond market, and in particular the high-yield bond market where money is lent to riskier companies, is often one of the first to pull back if economic conditions worsen to the point of threatening corporate balance sheets.

Given everything investors are worried about right now, from the Russian invasion of Ukraine to runaway inflation to an aggressive Federal Reserve taking the punch out of investors by tightening monetary policy, they should be keeping an eye on the bond market. high perfomance. But in recent periods of stress, he hasn’t really moved. Instead, the stock market has been the most receptive.

Take this year. In January, the S&P 500 entered correction territory, defined as a move of more than 10 percent below its recent high. Meanwhile, high yield bonds fared much better. The difference in the yield of high-yield bonds and US Treasuries, a measure of the risk of lending to private companies versus the government, increased a bit but remained well below any signs of distress. . Why weren’t credit investors more concerned? Why aren’t they yet?

Arguably that’s because this year’s stock volatility is not due to fundamental weakness in the economy, but to the resetting of expectations about interest rate hikes by the Federal Reserve. If this is correct, credit has been giving the correct signal: that all is fundamentally well.

However, concerns about economic growth are emerging. The US yield curve invested this week, with interest rates on long-term bonds falling below short-term debt. This is considered a classic indicator of a recession because it implies that longer-term rates will need to be cut to avoid an economic downturn. Interest rate markets also forecast that the Fed will have to cut rates in just over a year after raising them aggressively, pointing to fears that attempts to curb high inflation will choke economic growth.

Still, the high-yield bond market is largely baffled.

There are explanations. Analysts are looking at a number of measures that suggest the high-yield bond market is less risky than it used to be. For example, low rates have allowed businesses to borrow cheaply, increasing the likelihood that they will continue to pay their debts. Perhaps the market is simply not as sensitive to recession as it once was.

“Most companies have a big gap between current economic conditions and something that could significantly affect their ability to repay credit, so stocks almost have to move first,” said Peter Tchir, global macro strategist at Academy Securities.

Matt Mish, a credit analyst at UBS, suggests there will be stress in the loan market, which has been used by private equity firms to finance aggressive corporate takeovers. Data from S&P Global shows that the share of corporate bonds rated low, B and below has shrunk from about 80 percent of the high-yield bond market in 2000 to just under 50 percent today. By contrast, that same share of the loan market has risen from 50 percent to nearly 80 percent.

Even here, however, the stress is unlikely to manifest anytime soon given that the vast majority of syndicated loans are held by structured investment vehicles called collateralized loan obligations, which lock up investors’ money and are less pressured to sell. loans.

Are these changes in financial markets obfuscating tried and true indicators of future turmoil? Possibly. However, the most obvious conclusion remains that the risk of a recession simply remains low for now.

Consumer balance sheets, on the whole, remain strong. Labor markets are tight. If companies can weather inflation, and the Fed’s response to it, then maybe all will be well. S&P raised its default forecast to 3 percent by the end of the year. That is still very low. For now, it appears that the high yield bond market is willing to ignore current macro concerns. Perhaps there are some bulls in the bond market after all.

joe.rennison@ft.com

Previous post It’s never easy to take the plunge
Next post Russia’s economy is collapsing, devastated by Putin’s war in Ukraine
%d bloggers like this: