Europe is now in its worst corporate-bond selloff in decades

Due to central banks around the world tightening monetary policy in an attempt to tame spiraling inflation.
Image: Shutterstock

By almost any metric, this is Europe’s worst corporate-bond selloff in decades, surpassing even the 2008 financial crisis.

Whether you look at returns, the speed at which yields have risen, or the length of the selloff, investors face a historic pummeling. An index of investment-grade European debt has fallen seven months in a row, its longest losing streak since its inception in 1998. The 12.9% loss over the past 12 months is also the worst in its history.

The plunge, a dramatic turnabout from three decades of largely favorable markets, is the result of central banks around the world tightening monetary policy in an attempt to tame spiraling inflation.

“We’ve been down most months this year,” said Kyle Kloc, a senior portfolio manager at Fisch Asset Management. “You very rarely get these types of repeated negative returns.”

The selloff is more intense than two comparable periods, he said: the onset of the Covid-19 pandemic, which lasted only weeks before central banks calmed markets, and the great financial crisis, which was a series of “sharp, quick drops.”

Investors now are trying to parse how much rate hikes have already been priced into the market, and thus how much longer the corporate bond rout will last.

Rate rises
UK inflation came in at 9.1% on Wednesday, with traders betting on 160 basis points more tightening from the Bank of England this year, while economists predict the US Federal Reserve will boost its benchmark rate 75 basis points again in July and the European Central Bank will end negative rates this autumn.

ECB Governing Council member Mario Centeno said on Friday that the normalization of the ECB’s monetary policy will be done gradually. That prospect didn’t stop European fixed-income funds experiencing their worst week for outflows since March 2020, according to EPFR Global data cited by Bank of America analysts.

“This is probably one of the most challenging years we’ve been in — but also one of the most interesting ones in terms of asset management,” said Gregoire Pesques, head of the global credit team at Amundi SA, Europe’s biggest money manager.  “‘Given that the liquidity is still there, there are opportunities to be found — and increasing attractiveness in terms of yield.”

Meanwhile, recession indicators are flashing, with copper prices — considered a bellwether for the global economy — dropping to a 14-month low.

For bond watchers, the higher borrowing costs faced by corporations will only push down harder on the economy’s brakes. “We could see earnings impacted because of this rather unexpected rise in the cost of debt,” said Timothy Rahill, a credit strategist at ING.

The average yield on euro corporate bonds has risen 2.9 percentage points this year to 3.4%, according to a Bloomberg index. This compares to a rise of 1.62 points in 2008, the next highest.


There is one way in which corporate bonds fared worse in previous crises: the spread between what borrowers paid and the benchmark rate widened more during the euro-zone debt crisis of 2010-2012, for example.

But this compounds the problem for bond investors; unlike at that time, the underlying benchmarks such as German bunds also have sold off sharply now, leaving them with few options to invest their money. And even here, option-adjusted spreads rose above 200 basis points on Friday — a level previously seen almost exclusively when a major risk event was taking place.

As corporate bonds begin to mature in this environment, the spike in borrowing costs will really make itself felt, both in credit ratings and companies’ ability to pay back their debts.

“In other words, more downgrades and more defaults,” said ING’s Rahill.

Elsewhere in credit markets:

EMEA
There were no new deals in the EMEA region on Friday after a week in which issuance exceeded expectations amid widening credit spreads and concerns around a potential recession started to surface.

  • Money markets are quickly paring wagers on how much tightening the European Central Bank stands to deliver this year as they worry the region could slip into a recession
  • Once a darling of the renewable energy industry, Abengoa has been struggling for years. Now, its key operating company is at risk of collapse after a government agency turned down a request for an emergency lifeline
  • A fund backed by Elliott Capital Management provided British clothes retailer Matalan Ltd. with a rescue loan to help it refinance debt due in July
  • Universal Music Group on Thursday became the fourth non-financial corporate borrower this week to offer two part euro-denominated bonds, following in the footsteps of BASF, VW Financial Services and Rentokil Initial Finance

Asia
Asian high-grade dollar bond spreads headed for a second straight day of widening as recession concerns sapped investors’ risk appetite, and that also slowed activity in the primary market on Thursday.

  • Dollar bonds weakened after Federal Reserve Chair Jerome Powell acknowledged the risk of recession: spreads on the region’s investment-grade notes increased at least 2bps on Thursday, while Chinese junk notes fell 1-2 cents on the dollar on average, credit traders said
  • Worries about the outlook for China’s private-sector property firms weighed on sentiment as well after its largest developer Country Garden Holdings was downgraded to junk level by Moody’s Investors Service on Wednesday
  • Changde Economic Construction Investment Group was the only issuer to market a dollar bond in the region
  • Meanwhile in the Chinese credit market, the Credit Derivatives Determinations Committee on Wednesday accepted a request to consider a “Failure to Pay Credit Event” event on a Shimao dollar bond due June 14, according to a statement; that pressured the firm’s onshore and offshore notes on track to fresh lows
  • Chinese conglomerate Fosun International told Bloomberg News in a statement Thursday that it has abundant available funds and will continue to manage its debt “in advance in various ways in the future”

Americas
US high-grade bond investors have pulled cash from funds that buy the debt for 13 consecutive weeks, extending the longest losing streak on record.

  • An outflow of about $7.5 billion for the week ended June 22 follows last week’s $8.7 billion withdrawal, Refinitiv Lipper data show. The total amount of exits during this stretch has now reached $55.7 billion, according to the data
  • The biggest buyers of US leveraged loans are increasingly turning to the bond market to find better value
  • Money managers that buy syndicated bank loans and package them into US collateralized loan obligations have started adding more corporate bonds, according to a recent report from U.S. Bancorp
  • No high-grade deals or investor outreach events were announced after three borrowers shrugged off a softer backdrop and weak open Wednesday to price just over $3 billion in new debt
  • New York’s biggest mall, Destiny USA, has reached a deal with lenders to avoid a default after the pandemic and years of retail turmoil left it deeply underwater on its mortgages
  • Avaya Holdings Corp. is offering the highest margin of the year on a leveraged loan that will refinance an upcoming convertible bond maturity, another sign of how much borrowing costs have risen for risky US issuers during a rout in credit

© 2022 Bloomberg L.P.

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