Global corporate bond returns just hit their highest level this year on bets that the inflation crisis is coming to an end. Some investors say this may be as good as it gets, with dangers lurking in credit markets for the second half.
Returns for global investment-grade and high-yield debt have jumped to 5.47%, above February’s high, according to Bloomberg calculations. A swift rebound came after positive US inflation data spurred bets that Federal Reserve interest hikes will come to an end, sparking a rally for government bonds.
At the same time, corporate bonds’ spread over government debt is now at its lowest since early March, prompting questions about whether investors are being compensated for risks that include an uneven global economic recovery and a looming maturity wall — a particular issue for lower-rated borrowers with refinancing needs.
“This bullish trend will be difficult to maintain for the second half of the year,” said Eric Vanraes, head of fixed income at Eric Sturdza Investments and a 32-year credit market veteran. “The problem is that with a risk-free rate at 5.5%, we are becoming more demanding with other assets,” he said, referring to US government securities.
Part of the problem for investors is that it may seem like they have been here before. At the start of the year, the likes of UBS Group AG were touting a “once-in-a-decade opportunity” in corporate bonds. By March, as inflation proved to be stickier than expected, returns had slid to almost zero. Turmoil in the banking sector for the next few months also triggered a slump in parts of the market.
And while the latest US — and UK — inflation data has been good news, figures this week showed euro-area core consumer prices accelerated more than initially reported in June.
For some investors, the solution now is to be more picky. Dario Messi, a fixed income analyst at Julius Baer, recommends focusing on investment-grade bonds — which are more sensitive to interest rates — while being selective when it comes to junk bonds.
“Riskier segments are still not very appealing in light of the ongoing default cycle,” Messi wrote in a note on Wednesday. “We would only opt for better-rated credits within the riskier segments.”
That sentiment was echoed by credit strategists at Bank of America Corp., who said that after the recent rally, high-yield positions are harder to justify than investment-grade ones. “Caution is needed at this juncture,” strategists Ioannis Angelakis and Barnaby Martin wrote in a note on Thursday.
They highlighted second-half risks including macroeconomic headwinds in Europe and an influx of corporate bond supply in September. Elevated government bond yields will also curb demand for corporate debt, they said.
For now, however, it seems that the appetite for risk is back. Junk borrowers are piling into the leveraged loan and high-yield bond markets to refinance debt and fund acquisitions. In the world of leveraged buyouts, more benign conditions are making it easier for banks to sell on debt to institutional investors.
And if the US manages to achieve a so-called soft landing for the economy, corporate bonds could see a further boost, according to Felipe Villarroel, a portfolio manager at TwentyFour Asset Management. “If the central case becomes a soft landing, that would typically mean that credit outperforms,” he wrote in a note on Tuesday. “Treasuries would provide a reasonable return as well but credit would do better.”
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