Rising fiscal deficits drive billions into credit
[NEW YORK] Investors are showing signs of pulling money out of government bonds and ploughing it into US and European company debt.
If the moves persist, money managers could be shifting what for decades has been market orthodoxy: that nothing is safer than buying US government debt. But as US fiscal deficits climb, hurt by tax cuts and rising interest costs, the government may look to borrow more, and company debt may be the safer option.
In June, money managers pulled US$3.9 billion from Treasuries, while adding US$10 billion to European and US investment-grade corporate debt, according to EPFR Global data. In July, investors have added another US$13 billion to US high-grade corporates, the largest net client purchasing in data going back to 2015, according to a separate note from strategists at Barclays on Friday (Jul 25).
Michaël Nizard, a portfolio manager at Edmond de Rothschild Asset Management, started making the switch from government into corporate debt at the end of last year and is holding on to the position.
And in a note in the latest week, BlackRock strategists wrote: “Credit has become a clear choice for quality.”
To the extent this shift is happening, it’s a slow change. The US doesn’t have foreign currency debt, and can print more US dollars as it needs to. When money managers were alarmed about tariff wars in April, US Treasuries still performed better than corporate bonds, even if prices for both sectors broadly fell. And foreign demand for Treasuries has remained resilient, with holdings climbing in May.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
But tightening corporate bond spreads in recent months may be a function of government debt looking relatively weaker now. The US government lost its last triple A grade in May, when Moody’s Ratings cut it to Aa1. The bond rater pointed to factors including the widening deficit and the rising burden of interest, noting that payments will likely absorb around 30 per cent of revenue by 2035, compared with 18 per cent in 2024 and 9 per cent in 2021.
And US President Donald Trump’s sweeping tax cut bill could add about US$3.4 trillion to US deficits over the next decade, according to projections from the nonpartisan Congressional Budget Office.
At the same time, corporate profits remain relatively strong, and although there are some early reasons for caution, high-grade companies are generally generating enough earnings to easily pay their interest now. More US companies are topping earnings estimates this reporting season than the same period last year.
Valuations for company debt have been high recently, reflecting investor demand for the debt. High-grade US corporate spreads have averaged below 0.8 percentage point, or 80 basis points, in July through Thursday. That’s far below the mean for the decade of about 120 basis points, according to Bloomberg index data. Spreads for euro-denominated high-grade corporates have averaged about 85 basis points in July, compared with about 123 basis points for the decade.
To some money managers, high valuations for corporate credit are cause to be wary. Gershon Distenfeld, a fund manager at AllianceBernstein Holding, pared back a position that favoured credit risk to rates risk earlier this month. Dominique Braeuninger, a multi-asset fund manager at Schroders Investment Management, agrees that corporate bond spreads are too tight to make them attractive.
And even if BlackRock is generally positive on corporate debt, it is underweight long-term high-grade notes because spreads are tight, while being overweight short-term credit.
But to many market observers, the world appears to be shifting, and it makes sense to hold more corporate debt now.
“What we’ve seen on the government fiscal side is not great news,” said Jason Simpson, a senior fixed income SPDR ETF strategist at State Street Investment Management. “Corporates seem to be chugging along nicely.” BLOOMBERG
Share with us your feedback on BT's products and services
