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The $793 Billion Credit Market Recovery Is on Shaky Ground

The $793 Billion Credit Market Recovery Is on Shaky Ground

(Bloomberg Opinion) -- Does the global central bank response to the Covid-19 crisis mean it’s safe for corporate-bond investors to go back into the water, or is the market just experiencing a temporary sugar rush?

The blowout in credit spreads (the difference between yields on bonds and those of their benchmarks) has abated. Almost half of the widening from the early days of the coronavirus lockdowns has been reversed, and the spread is steadily tightening. Investor optimism is returning, except in heavily affected industries such as carmaking and aviation.

The $793 Billion Credit Market Recovery Is on Shaky Ground

As ever, investors are desperate for yield, which is driving the improvement. But with more ugly economic data bound to come, this is an uncertain recovery. While it looks like the worst is over, another flare-up in virus cases and a return of lockdowns could easily see the market for new bond issues slam shut again and spreads blow out once more.

At least we haven’t seen many corporate defaults. Most companies appear to be pretty well managed and able to survive a recession, even if leveraged. Helped by government and central bank action, most are finding access to capital that will last them until the end of 2021. The relaxation of bank leverage limits should help lenders keep the taps on for solvent company borrowers, and let businesses secure more longer-term finance.

The new-issues market for corporate debt looks solid for now, though companies are having to offer much higher interest rates than before. More than 730 billion euros ($793 billion) of new syndicated debt has been raised in Europe this year, a record amount. Some 90% of new issues in April have seen their yields fall subsequently. The junk-bond market is showing signs of life, with three new euro issues from Verisure Holding AB, Netflix Inc. and Merlin Entertainments Ltd.

The $793 Billion Credit Market Recovery Is on Shaky Ground

However, it’s inevitable that records will be broken when corporate treasurers are seizing the moment to make sure their companies have enough money to survive. This is a highly unusual situation, which is backstopped by the central banks. Furthermore, we haven’t really felt the impact of the so-called “fallen angels,” those who have just lost their investment-grade credit ratings. Analysts at JP Morgan reckon there will be 100 billion euros of newly junked debt this year. That might force index funds to sell the bonds, depressing their prices even further and increasing borrowing costs for some big employers. 

Corporate issuers will also have to reckon with the avalanche of competing government supply that’s headed our way to pay for the huge coronavirus-related spending packages. If this swallows up investor demand, the yields on corporate debt may have to increase to secure people’s interest. The pressure on company credit will only be kept at bay with continual quantitative easing and confident investor demand. As I’ve argued before, the central banks need to share the love with junk-rated companies too if the real economy and employment is not to suffer excessively.

For now, the European Central Bank's investment-grade bond buying is making a difference. Its corporate program is now up to 207 billion euros, an increase of 27 billion euros this year. It’s in the balance whether there might be some rule changes at the next ECB Governing Council meeting on Thursday to include fallen angels in the pandemic QE program. If Christine Lagarde follows the U.S. Federal Reserve’s lead in opening up to high-yield debt, it could make a significant difference to junk-bond spreads too. That might reduce further the risk of a euro-zone credit meltdown.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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