Credit investors venture back after worst quarter since 2008

[NEW YORK] The worst losses in credit markets since the global financial crisis are likely over for now as companies that loaded up on cash grow adept at navigating faster inflation and investors who yanked money from fixed income bring some of it back.

That's the view of some of the more optimistic investors, who have taken heart in a recent rally. Bloomberg's multi-currency corporate bond index recorded its best performance in more than 16 months last week. Still, it lost 7.1 per cent in the first quarter, the biggest slump since 2008.

JPMorgan Chase & Co analysts argue the rotation away from bonds into equities is likely to let up, with less selling in the second quarter. Elisa Belgacem of Generali Investments remains overweight on credit, and Deutsche Bank sees investment-grade spreads declining over 12 months.

"Credit looks in a reasonable state to weather this particular storm. With strong balance sheet cash positions and record-low default rates the case appears to remain fundamentally positive" for credit in developed markets, Christian Nolting, global chief investment officer for Deutsche's private bank, wrote.

"Bouts of technical selling pressure are to be expected, though, whenever risk sentiment sours due to the conflict situation or other factors like inflation spikes" and central bank action.

The war in Ukraine is expected to shave more than 1 percentage point off global growth this year and drive up inflation by a further 2.5 percentage points from already-high levels. Federal Reserve projections point to rate hikes through each of the remaining meetings in 2022.

Further complicating the picture for the bond market: The Fed plans to begin reducing its US$8.9 trillion balance sheet sometime in the coming months. Potentially in anticipation of a still higher cost of capital, issuers from around the world sold more than US$229 billion of debt in the US high-grade market in March, one of the biggest months on record, according to data compiled by Bloomberg.

On Monday (Apr 4), 6 companies borrowed in the US high-grade market, including Credit Suisse Group's sale of US$2.5 billion of notes.

Activity is also gaining pace in Europe, with East Japan Railway Co and Blackstone Private Credit Fund among a raft of issuers announcing planned deals. Average euro borrowing costs for high-grade firms eased to about 130 basis points. Spreads have tightened for 3 straight weeks after an extended run of widening that began in mid-January.

"Technicals should prove resilient in the near term, with flows stabilising and high absolute yields attracting yield-sensitive investors back into the asset class," according to Generali's Belgacem. Still, "we expect a worsening in default rates in Europe."

After a strong increase following the invasion of Ukraine, yield premiums on investment-grade dollar bonds have tightened for 3 consecutive weeks, a Bloomberg index shows.

But with an inverted US Treasury yield curve flashing warning signs, Goldman Sachs Group strategists last week recommended that investors take advantage of the tightening in credit spreads to reduce risk and shift up in quality in high-yield notes. They argue spreads have likely reached the lower end of their range and expect investment-grade yield premiums will widen to 123 basis points in the fourth quarter, compared with the 111 basis points on a Bloomberg index on Monday.

The Wall Street bank isn't alone in that view.

"I am not so super bullish for the market," said Holger Mertens, a credit portfolio manager at Nikko Asset Management who is focusing on relative value bets to boost performance. "I wouldn't be surprised if we see the old wides again" of 145 basis points or higher. BLOOMBERG