Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Investors are selling out of the riskiest US junk bonds in favour of higher-quality debt, amid a surge in bankruptcy filings and concerns over how the weakest corners of corporate America will survive a prolonged period of high interest rates.
The gap in borrowing costs between companies rated triple-C and lower — the lowest rungs of the $1.3tn US junk bond market — and double-B — the highest rung — has surged to almost its widest level since May last year, according to Ice BofA data, as investors seek safer names.
The move highlights how traders are growing increasingly concerned about weaker companies potentially losing access to funding and defaulting on their debt as borrowing costs stay high, and are instead opting to buy the debt of stronger companies for the yields on offer.
The sell-off in riskier names is “a reflection of worries about the cocktail of higher for longer and the risk of a recession, which would ultimately be of course very bad news for the most highly levered companies”, said Torsten Slok, chief economist at investment firm Apollo.
The sell-off in the lowest-quality debt adds to concerns about how quickly the US Federal Reserve will cut rates and the extent to which high rates will damage the economy in the meantime. Market expectations have swung wildly this year: investors are currently pricing in about two quarter-percentage-point cuts this year, having expected six or seven in January.
On Tuesday, Fed chair Jay Powell said “elevated inflation is not the only risk we face” and leaving borrowing costs too high for too long could “unduly” damage the economy.
Analysts and investors said higher-grade borrowers typically had more flexibility to handle interest rates at their current 23-year highs, while lower-quality names were more vulnerable.
The premium or “spread” paid by triple-C rated companies to borrow over equivalent Treasury yields rose as high as 9.59 percentage points last week and on Tuesday stood at 9.51 percentage points, according to Ice BofA data. That is up sharply from less than 9.3 percentage points in early June, signalling that investors are demanding more compensation for a greater risk of default.
In contrast, the average spread for double-B junk bonds has remained broadly stable over the same timeframe at roughly 1.9 percentage points.
“Triple-C rated issuers are the least well-equipped to navigate ‘higher for longer’,” said Brian Barnhurst, head of global credit research at PGIM Fixed Income. “They have higher interest burdens, more constrained cash flows to begin with, more constrained liquidity, perhaps less business flexibility.
“Higher for longer heightens the risks that they’re going to run into problems,” he added.
Investors are also concerned that weakening US consumer confidence is adding to the increasingly challenging environment for lower-grade companies.
“There are concerns around the US consumer being priced into the high-yield market,” said Bob Schwartz, a portfolio manager at AllianceBernstein.
Junk bond spreads overall remain much narrower than they were even a year ago, helped by investors piling back into corporate debt to lock in yields before the Fed starts to cut rates. This has created a supply-demand imbalance, due to relatively little new issuance.
Nevertheless, data from S&P Global Market Intelligence this week highlighted the broader pressures already being endured by a number of US companies, with year-to-date bankruptcy filings totalling 346, the highest level for this stage in the year since 2010.
Among recent bankruptcies are electric-vehicle group Fisker Group Inc and its parent company Fisker, along with media company Chicken Soup for the Soul Entertainment.
But in a sign of how smaller businesses are feeling much of the pain, almost all of the companies that filed for bankruptcy protection in June had less than $1bn in total liabilities, according to S&P’s data.
Calculations of corporate default rates vary in terms of scope and scale, with some research pointing to a levelling out and gradual decline of defaults in the coming months.
However, on Thursday a quarterly survey showed that the International Association of Credit Portfolio Managers — whose members include banks and investment managers — are predicting rising defaults over the coming months, “with some saying they’re already seeing an increase, especially among smaller borrowers”.
Analysts also believe recent concerns over President Joe Biden’s age and chances of re-election, following a disastrous performance at a June 27 debate with former president Donald Trump, are hitting the bonds of weaker corporate borrowers as investors fear that rates may have to stay elevated as a result.
The possibility of a second Trump presidency means investors are anticipating “even more pressure on the government balance sheet, more fiscal stimulus”, said PGIM’s Barnhurst.
“Those things are presumed by the market to be some degree inflationary, which only adds to the notion of higher for longer.”
Read the full article here
