As a result of persistent inflation statistics, market participants have changed their minds about the timing of rate cuts by central banks, which has caused the best corporate bonds to wipe out nearly all of their early-year gains. According to Bloomberg indices, the total return from that debt has been a dismal 0.67% since the beginning of 2023. This comes on the heels of the worst February in recorded history.
After setting a new record high in January for the same metric, high-grade bonds have experienced a dramatic reversal in their performance. The “year of the bond” narrative, which suggested that buyers of the safest credit couldn’t go wrong thanks to the highest yields in approximately a decade, risks being flipped as lingering inflation and the fading likelihood of a rate cut by the Federal Reserve this year put pressure on the narrative.
Said Viktor Hjort, global head of credit strategy and desk analysts at BNP Paribas SA
“The risks are skewed to the downside: spreads should go wider,”
“There’s been a nice growth narrative of late but I’m concerned that the market underestimates the fact that most policy tightening in the US and Europe has yet to hit the economy and corporate fundamentals.”
After only four weeks since the market’s top on February 2, the value of the global high-grade bond market has dropped by roughly $327 billion, which is more than the country of Chile’s gross domestic product. On Tuesday, the market continued its downward trend, with data revealing everything that credit bulls had hoped to avoid seeing.
First, inflation statistics in France and Spain that were far higher than projected stoked expectations of a robust response from the European Central Bank. Later on in the day, bond traders lowered their forecasts of a rate decrease by the United States in this year to the level of a coin toss.
‘Bumpy Ride’
Kathy Jones, chief fixed income strategist at Charles Schwab & Co., said in an interview that money markets are currently placing even odds that the Fed Fund range will peak at between 5.50% and 5.75% by July. This means that credit markets are in for a “bumpy ride.” The market will continue to be subject to the effects of volatility until there is a “clearer picture” of what the expectations of the central bank are.
For the time being, asset owners are not deterred by this fact as they continue to flock into fixed-income instruments, enticed by yields that are almost double the average of the previous ten years.
According to statistics gathered by Bank of America and EPFR Global, European bond funds that invest in high-grade debt have been successful at attracting investor capital for the past 18 weeks in a row. Just for this year, there has been an inflow of roughly $27 billion. This year, investment-grade funds that are headquartered in the United States have added roughly $41 billion.
Mark Benstead, head of pan-European credit at Legal & General, said that higher yields are supportive of ongoing inflows into the asset class. “Higher yields are supportive of ongoing inflows.”
Borrowers rushed to the market to take advantage of the froth of money in especially in the month of January in order to capitalize on the inflows. According to figures provided by Bloomberg, since the beginning of the year, investment-grade bonds with a total face value of more than $300 billion have been issued in the United States alone.
A Hurry to the Market
Dave Del Vecchio, co-head of US investment grade corporate bonds at PGIM Fixed Income, stated in an interview that a significant number of the deals were sold earlier than originally planned. According to him, the fact that there were less debt financings for acquisitions and fewer debt issues in March should help improve the month’s technicals.
James Dichiaro, senior portfolio manager at Insight Investment, said in a message-
“While investors are happy to earn a higher degree of income within markets they are also scarred from the price action of 2022”
“The specter of yet higher rates from here is enough to cause investors to pull back, reassess, and await a better entry point, which we have witnessed in February.”
After having their worst year on record the previous year, money managers have become increasingly more conservative, focusing on high-quality borrowers or passing on new issues that offer little in the way of price sweeteners. This comes as a direct result of blue chip corporate debt having its worst year on record the previous year.
More recently, investors have been vocalizing their preference for short-dated debt, which pays as much — if not more — than longer notes but with little risk of price plunges as yields continue to go higher. Investors prefer this type of debt because it pays as much as — if not more than — longer notes.
Said Al Cattermole, a portfolio manager at Mirabaud Asset Management-
“Investors need to have a longer-term horizon”
“If you don’t need the money in six weeks, this is a very attractive asset class.”
Undoubtedly, the portion of the credit market that is most sensitive to rate changes has been the primary target of the setback this time around. Because their yield is less subject to the fluctuations in the price of government bonds, junk-rated bonds, which typically have a shorter duration than investment-grade debt, have maintained their 2.4% gain so far this year. But, even they have surrendered the majority of the gains they made in the first part of the year.
Nonetheless, a prolonged effort to curb growing consumer prices could wind up having a negative impact on the economy and profitability, adding to the difficulties faced by credit investors.
Said Pauline Chrystal, a portfolio manager at Kapstream Capital in Sydney-
“The strength of the rally in the first six weeks or so of the year surprised us a bit as our base case scenario for 2023 was higher rates eventually leading to a slowing economy, lower earnings and higher cost of funding”
“We have seen a bit of a rerun of 2022 – rates sell off and credit sells off.”
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