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The motto in markets right now is “shut up and take my money”, as the fear of missing out seeps into almost every major asset class. Nowhere is that clearer than in corporate bonds.
This market has struggled for the mainstream limelight this year, bumped out of view by the seemingly unstoppable juggernaut that is stocks. But just as stocks have ripped higher over the past six months, corporate credit is on the receiving end of rampant investor demand too.
The whole way in which fund managers talk about credit has shifted. For years, they touted spreads — the gap in returns that meant investors are rewarded more generously for buying corporate debt than for typically safer, more boring government bonds. This was the foundation of credit investing.
Now, persistent buying interest has squashed those spreads to the tightest point in decades. Investors earn almost no pick-up at all for taking on this extra risk; indeed in some peculiar cases they pay more for corporate bonds than government debt. Spreads are so pre-Covid, all-in yields are the name of the game.
“We have had massive inflows and it’s all about the yields,” said Heather Ridill, a credit strategist at Loomis Sayles, at an event in London earlier this month. “We say ‘spreads are tight’ and they say ‘we don’t care, we want the yields’.”
This does not sound terribly healthy, but it is easy to see how it has come about. For one thing, corporate debt is in short supply, especially when taking into account the relatively large amounts companies are returning to investors in the form of bond repayments.
Crucially, benchmark interest rates have dropped since the pandemic-era surge in inflation, but they remain reasonably generous by the standards of the past 15 years or so. This sets a higher floor for corporate borrowing costs, provides more of a cushion to investors if things go wrong and reinforces the point about credit scarcity — companies are more reluctant to go cap-in-hand to bond investors when they know it will be a relatively expensive exercise. For investors, the spread may be super thin, but it’s better than nothing. “You get something extra,” said Tatjana Greil Castro, co-head of public markets at credit investment house Muzinich. “It’s not a lot but it adds up over time.”
Riskier borrowers are often going down the route of private rather than public debt markets, which means the firms still tapping in to public bond investors’ largesse tend to be safer, and therefore worthy of higher ratings and lower borrowing costs. Goldman Sachs notes that even the riskier so-called high yield end of the market is “less junky than ever”. Idiosyncratic risks are par for the course in risky corporate debt, “but the high-yield index is now likely the safest it has ever been from a risk perspective”, the bank wrote earlier this month.
Some even argue that corporate debt often deserves to come with a higher price tag than benchmark government bonds, given companies’ greater ability to cut costs and, often, lower overall relative debt levels. It’s a slightly funky assertion, given companies cannot print their own money like governments can, or engineer inflation to melt debt burdens away, but the market has been blowing this way of late, especially given the political ructions in France.
Enough is enough, some investors say. They don’t feel properly compensated for buying in to the skinny yields of corporate debt so they head to stocks instead, or if it’s safety they’re after, they just buy government bonds with only slightly less generous returns.
But overall flows in to the asset class have been impressive all year. Indeed, Ridill at Loomis Sayles says the market is prone to bursts of instability on days when inflows are just a little slower than usual. Outright outflows would likely cause a “massive panic”, she added.
In the grip of this buying frenzy for corporate bond funds, one piece of comfort is that in primary markets — where banks launch new bonds out in to the world — discipline is still just about holding, bankers and investors say. Fund managers are not willing to buy at any old price, and they do tend to back away when bankers test their luck with miserly returns.
Nonetheless, the one-way traffic is unnerving. It reflects how across the board, from stocks to gold and silver and crypto, momentum is proving to be an irresistible force at the moment. It is not just stocks that are melting up — pretty much everything else is too.
“There’s definitely a huge fear of missing out,” said Greil Castro. “Everyone was fearful of a recession in 2023, 2024, so a lot of people still feel that they don’t have enough risk in their portfolios.”
This kind of hubris and enthusiasm is all fine until it is not. Some of the biggest names in finance, including Citi’s Jane Fraser, JPMorgan’s Jamie Dimon and Apollo’s Marc Rowan have all warned in the past week about excesses in global markets. Only the wilfully ignorant can fail to see that risk-taking is running at an alarmingly aggressive pace across almost every asset class.
Most likely, the only thing that can turn the tide in corporate credit would be a turn of the tide across the entire financial system. No risky asset class would be spared if the mood soured.
katie.martin@ft.com