Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
A rally in corporate bonds has pushed the reward for taking extra credit risk to historic lows, prompting warnings from some investors of “bubble-like behaviour” in parts of the market.
Corporate bonds have been swept up in a huge rally for risky assets since early last year that has also driven stock markets to a string of record highs, helped by expectations that the Trump administration will run the US economy “hot” this year, boosting global growth.
The average additional borrowing cost — or spread — that highly rated US and European companies pay compared with government debt has fallen to its lowest since before the 2008 global financial crisis, while the extra yield offered by more risky debt has also shrunk markedly.
That has led tech giants such as Alphabet and Oracle to take advantage of the highly favourable market conditions with large bond sales. But it is also making some investors increasingly wary.
“Credit markets have increasingly exhibited bubble‑like behaviour since late last summer,” said Nuwan Goonetilleke, head of capital markets at FTSE 100 insurer Phoenix Group, a big buyer of corporate and government debt, pointing to the compression in yields.
In response, Phoenix has sold some of its corporate debt positions and allocated to other areas of fixed income such as gilts, while it has also opted “to move up in quality, to ensure we are best positioned for any repricing”, Goonetilleke said.
The tight spreads reflect rampant demand from bond investors attracted by higher overall levels of income from the debt than during the post-crisis years, helped by a sharp pick-up in government bond yields. Some investors have preferred to buy the debt of companies, many of which have been more conservative in their borrowing than free-spending governments.
That has helped push down the spread between A and double A-rated global corporate bond indices provided by Ice BofA this year to below 0.2 percentage points for the first time, in data stretching back to 1997.
The gap between yields on triple B and A-rated global corporate debt has fallen to just above 0.3 percentage points, close to its lowest since before the financial crisis.
Alphabet, which is rated double A plus by S&P, this week seized on the massive demand by raising a rare 100-year bond, while Oracle, which is rated triple B by S&P, raised $25bn last week, despite credit downgrade pressure amid investor concerns about its rising debt due to AI spending.
“It was smart of them [Oracle] to issue when spreads are this tight,” said a US-based high-grade portfolio manager. “This deal would have struggled if people weren’t grabbing every little bit of meat on the table.”
Meanwhile, double B-rated cement maker Titan Cement last week priced a €350mn bond at about 1.1 percentage points over German Bunds. Debt sold by similarly rated corporates priced with an average spread of more than 1.9 percentage points last year.
The total yield on US investment-grade corporate bonds — the combination of the sovereign bond yield and the additional corporate spread on top — is close to 5 per cent, and remains higher than levels for most of the period since the financial crisis. That is largely because government bond yields have risen as central banks have increased their policy rates since the Covid-19 pandemic, and as concerns grow over the demand for record levels of debt issuance by big economies.
The higher yields, some investors say, are encouraging people to pay less attention to whether the spread component is adequately rewarding them for the risks. Some fund managers warn that such a compression of yields between different ratings buckets leaves investors vulnerable to an economic downturn.
“There are people who are buying yield and yield and yield, and they are not being compensated for the risk they are taking on,” said Ben Lord, a fund manager at M&G Investments.
Analysts at Citi said in a note last week that “the compression at the top creates significant asymmetric risk; the consequences of a market shock are now much higher”.
For some, that means investors have to be much more selective about what they buy and what they avoid.
“It is now a bond picker market,” said Matthew Brill, head of North America investment grade credit at Invesco. “There will be more winners and more losers this year. You can’t just buy a lot of triple B companies and expect the wave to take you in.”
Additional reporting by Euan Healy in London. Data visualisation by Ray Douglas