Rate Market Fear Gauge Is Warning for Corporates

Corporate bonds have been relatively resilient amid a global government bond selloff, but the strength may not last.

Bond market volatility, a measure of uncertainty about the direction of bond yields, is spiking. Historically, that has foreshadowed trouble for corporate debt, as nervous retail investors and others pull money from the market.

For now, company profits are strong and higher overall corporate bond yields in part reflect solid economic growth. But, as inflationary pressure builds, the Federal Reserve is boosting rates to slow that growth. Over time, higher rates can hurt the economy and squeeze profits, and corporate bonds are already priced with little margin for error, said Kelly Kowalski, head of investment strategy at MassMutual.

“The longer yields are elevated and volatile, the more restrictive financial conditions become and the more they weigh on economic activity, corporate margins, and credit quality,” Kowalski said.

The result may be that company bonds eventually underperform government debt, which would boost the extra yield relative to Treasuries that companies pay to borrow, a difference known as the spread. JPMorgan Chase & Co. strategists including Nathaniel Rosenbaum estimated this week that US high-grade corporate bond spreads should be about 0.07 percentage point wider than they are now based on historical measures of bond and stock market volatility.

Yields across bond markets have broadly jumped in the last month as oil prices have climbed and inflation fears have risen. Most benchmark US Treasuries now have yields above 5%, with five-year yields climbing above that threshold for the first time since 2007.

Corporate bonds have largely shrugged off these moves. US high-grade spreads were 77 basis points on Thursday, two basis points tighter than their levels at the start of the month. Money managers looking to fund future liabilities, such as pensions and insurers that sell annuities, often buy corporate debt when yields rise, supporting relative performance for company bonds.

“There’s a lot of market experience with times where rates go up in a fairly controlled fashion because the economy is actually good, is doing well. And in those cases, the shocks tend to be fairly short-lived and moderate,” said Robert Tipp, head of global bonds and chief investment strategist at PGIM.

Even so, some investors are preparing for potential weakening. The ICE BofA U.S. Bond Market Option Volatility Estimate Index, known as the MOVE index, surged to about 105 basis points this week, its highest level since March and far above its average of about 80 for the decade.

Those kinds of debt market volatility surges can be a prelude to corporate spreads rising, as in early 2023, when bond yields rose, as did the MOVE index. But the correlation isn’t perfect. And a separate measure of fear in US equity markets, the VIX, hasn’t jumped.

“Yield-oriented investors want higher yields, but they want stable, higher yields, and yields have been anything but stable,” said Tom Murphy, head of investment-grade credit at Columbia Threadneedle Investments.

The cost of protecting a portfolio of North American credits against default using credit derivatives has also edged higher recently, even accounting for changes to the constituents of the index, a sign that investors are getting a bit more antsy about default risk. The CDX Investment Grade Index was around 58 basis points on a roll-adjusted basis on Friday, compared with roughly 55 basis points at the end of August.

Climbing yields are already having an impact on corporate debt sales. US companies sold about $33 billion of bonds this week, falling short of the roughly $40 billion forecast by dealers. Several borrowers paid roughly an extra 6 basis points to investors earlier this week, and order books shrank. At least one issuer stood down on Wednesday.

Heavy investment-grade issuance in August was, in part, spurred by concerns that rates may go higher, with companies pulling forward their borrowing plans. Issuers have now become more cautious after the recent jump in Treasury yields, said Maureen O’Connor, global head of high grade debt syndicate at Wells Fargo.

“The conversation has become more nuanced recently. As 10-year Treasury yields are now comfortably north of 5%, the question has shifted to whether the bond market is oversold. This could be a catalyst for some opportunistic issuers to pause their funding plans,” O’Connor said.

Higher yields typically hit prices on longer duration bonds first, and it often takes time for rising borrowing costs to translate to defaults. If yields stay high, some companies will have trouble refinancing, particularly those that are rated in the lowest-trading CCC tier, as well as companies in private credit and software, strategists including Matthew Mish wrote in a note on Wednesday.

Some strategists and investors think it makes sense to buy higher-quality bonds and cut their credit risk.

“We have to think about ways in which we think these companies are going to be able to mitigate not only energy costs, but also rising interest rate costs,” said Nachu Chockalingam, senior credit portfolio manager at Federated Hermes Ltd.

“They’re having to refinance paper that was 3%, 4%. Now we’re almost double that. So we have to think about how these companies are going to maintain their liquidity and balance sheets in this environment where there is a huge amount of bottom-up pressure that they’re having to face.”

Credit Edge: Magnetar Eyes $600 Billion Stressed Debt

About $50 billion of US high-grade bond sales are expected in the coming week, according to an informal poll of dealers.In Europe, 75% of professionals surveyed forecast more than €35 billion ($39.9 billion) of sales next week.In the US, Bloomberg Economics expects the September nonfarm payrolls report, due Oct. 2, to show the economy added 80,000 jobs, below consensus expectations of 100,000 new jobs, which will do little to boost the case for a Fed rate hikeThe euro-area inflation report for September is due Oct. 2, with Bloomberg Economics forecasting the headline figure to rise to 3.5%, from 3.2% in August.In Asia, the Reserve Bank of Australia is expected to raise the cash rate by 25 basis points on Sept. 29China is set to issue its purchasing managers index data on Sept. 30, which could signal a modest pick up in growthThe Bank of Japan’s third-quarter Tankan survey, due Oct. 1, is likely to show business sentiment strengthened, as firm AI-related demand bolstered conditions for manufacturersFor an in-depth look at the data and events around the world that could impact markets in the coming week, see the Global Economy Week Ahead from Bloomberg Economics.

Week In Review

Paramount Skydance Corp. is looking to wrap up a massive $52 billion debt sale in the coming week to fund its takeover of Warner Bros. Discovery Inc., as it tries to close the deal before the end of the month to avoid paying penalties. A $7.5 billion loan sale kicked off on Thursday, and another $31 billion of investment-grade bonds and $12.4 billion of second-lien secured bonds are expected to hit the market in the coming days. The planned borrowing comes after the company settled lawsuits from 12 states attorneys general and the Writers Guild trade union that could have blocked the $110 billion acquisition.Masayoshi Son’s Softbank Group Corp. priced the largest junk bond offering on record with an $11 billion offering in dollars and euros to support its big bet on Open AI. To entice investors, the Japanese conglomerate had to offer yields above anything it’s paid before.Separately, Apollo Global Management Inc. expanded the size of its loan to SoftBank to $9.2 billion from $5.4 billion, handing the Japanese investing giant more cash as it boosts its investment in ChatGPT creator OpenAI.Oracle Corp. took a step to shield itself from racking up expenses on a massive data center project if construction is derailed and fails to come online 2028 as planned. It sent the project’s developer a notice citing force majeure, which could give it leeway to delay payments on its debt if the project runs into obstacles. The developer is a unit of Blue Owl Capital Inc.Brightline, the Florida private passenger railroad, filed for bankruptcy, seeking to restructure under court protection after years of lower-than-expected revenue left it unable to repay billions it borrowed.Goldman Sachs Group Inc. has emerged as the lead bidder to buy Palmer Square Capital Management, a collateralized loan obligation manager that oversees $37 billion. The Kansas-based firm, led by Chris and Angie Long, has expanded on the back of explosive growth in the global market for corporate loans bundled into bonds.Nuveen is planning its first sterling bond sale, along with three dollar-denominated issues, to fund the buyout of UK money manager Schroders.Blackstone is developing a hybrid CLO that blends broadly syndicated loans with private credit, following a blueprint pioneered by Sona Asset Management, which printed the first such vehicle late last month with 85 broadly syndicated loans and 20 private credit loans.Blackstone also shelved a $3 billion collateralized fund obligation deal designed to offload aging private equity stakes for one of its older secondaries funds, after potential buyers balked at the deal’s high leverage and the unusually old age of its underlying assets.Peloton Interactive Inc. is eyeing its first-ever bond deal, sounding out investors for a potential $800 million sale.Spanish soccer club FC Barcelona is talking to investors to gauge interest for a potential €300 million ($342 million) private debt placement to help finish a years-long revamp of its Spotify Camp Nou stadium that’s been mired with delays.AMC Entertainment Holdings Inc., a movie theater chain, wrapped up a $2.85 billion financing in the junk bond and leveraged loan markets that will overhaul much of its capital structure, seizing on renewed investor appetite for its debt amid a box-office recovery. The debt offering comes six months after AMC was forced to shelve a planned bond and loan sale amid a difficult market backdrop.

On the Move

Hudson Bay Capital Management is parting ways with two executives it hired from BlackRock Inc. as the $20 billion firm abandons plans to start a dedicated private credit business. Raj Vig and Tim Morris are leaving Hudson Bay.Citigroup Inc.’s head of North American leveraged finance, Scott Sartorius, has left the firm to join a US Commerce Department unit that oversees $39 billion in federal incentives for domestic semiconductor manufacturing.JPMorgan Chase and Co. has hired market veteran Adriaan van der Knaap to join its expanding private capital advisory and solutions team. Van der Knaap previously spent eight years at Apollo Global Management Inc., and joins the bank’s PCAS team as a vice chair in New York.Deutsche Bank hired Timo Koch from Strategic Value Partners LLC to work on capital solutions and direct lending deals.

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