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Corporate bonds lost $1 billion and there are more problems ahead

Corporate debt investors brace for further trouble after a rocky quarter as economic fears remain in place as an end to the war in Ukraine may prove elusive.

The world’s safest corporate debt pool has already shrunk by $805 billion so far this year, while the global junk market has lost $236 billion, according to data compiled by Bloomberg. It’s the biggest drop in the dollar since records began more than 20 years ago, following a borrowing spree propelled by record funding costs.

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

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

“We really have a lot of things to deal with,” said April Larusse, head of investment specialists at Insight Investments, which oversees 867 billion pounds ($1.14 trillion). And given that “there may be endless discussions and quite little progress” between Russian and Ukrainian negotiators, “it is probably not wise to make a big directional bet”.

Ukrainian perspectives
Skeptical NATO allies are weighing whether Russia’s pledge to scale back military operations in Ukraine marks a turning point in the conflict or just a tactical shift. Hopes for progress in negotiations have helped push global high-quality debt spreads below levels last seen before Russia’s February 24 invasion of Ukraine.

Losses came from all quarters, particularly in the investment grade market, which is more exposed to rising global government bond yields as central banks tighten policy. This is due to their higher duration, bond language for price sensitivity to changes in interest rates.

Yields on 10-year US Treasuries and German government bonds hit their highest levels since 2019 and 2018 respectively. U.S. two-year yields briefly rose above the 10-year level on Tuesday for the first time since 2019, signaling that rate hikes by the Federal Reserve could trigger a recession.

Meanwhile, the risk premium of corporate bonds over supposedly safe debt has also jumped since the start of the year. While spreads have reversed some of their widening in recent weeks, analysts expect pressure to resume.

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

Persistent risks
Yet what looks cheap now may become even cheaper later, especially as the risks that drove the first-quarter losses are likely to persist.

“Year-over-year excess return expectations from current levels are historically good,” said Greg Venizelos, credit strategist at Axa Investment Managers, which oversees 887 billion euros. “That’s not to say there aren’t any other downsides – it’s a good entry point but it could still improve in the coming weeks. It’s prudent to stay a little cautious.

To be sure, the steep price declines have allowed some investors to grab what they see as bargains at levels of spread not seen since the start of the coronavirus pandemic.

“We view investment grade 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, portfolio manager at Eric Sturdza Investments, which oversees $1.7. billion.

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

Elsewhere in the credit markets:

EMEA
Rabobank and CEZ AS are among 14 issuers bringing 18 tranches to the European primary market on Wednesday, for a minimum amount of 8.23 ​​billion euros. The Dutch lender is offering an additional Tier 1 rating, the riskiest type of bank debt, while the Czech gas distributor is ready for a benchmark-sized sustainability bond.

  • Weekly issue volumes are expected to exceed €24.3 billion, potentially taking year-to-date supply above the €500 billion mark
  • Payment for Swiss franc bond by Russian Railways not made for compliance reasons, filing says
  • Gold miner Petropavlovsk has entered talks with advisers for possible debt restructuring after its lender Gazprombank was added to the list of entities sanctioned by the UK.

Asia

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

  • Spreads on the region’s investment-grade bonds have narrowed at least 2-3 basis points, credit traders said, leaving them at the tightest level in more than a month, according to a report. Bloomberg index
  • Greenko Wind Projects Mauritius Ltd. can price its benchmark size green dollar bond with State Grid Europe Development and MISC Capital Two Labuan Ltd today.
  • Despite the respite from the recent bond market rout, some analysts are warning that more trouble may lie ahead for debt securities. Investors should improve credit quality as tighter liquidity conditions will make refinancing more difficult for fringe companies, according to Paul Lukaszewski, head of corporate debt for Asia-Pacific at Abrdn in Singapore.

Americas

High-risk companies that tapped into the $1.4 trillion US leveraged loan market were largely shielded from rising short-term rates. Now they are about to feel the pain.

  • Morgan Stanley’s head of US and European credit strategy Srikanth Sankaran said a rally in equity and credit markets on optimism about the progress of ceasefire talks between Russia and Ukraine is only a temporary jolt
  • U.S. bankruptcy courts recorded three large filings last week, making March by far the busiest month so far this year for large insolvencies

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