(Bloomberg) — Corporate debt’s halcyon days are showing signs of fading, with trade wars damping what had been a relentless demand for credit.
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“Cracks that appeared in the credit market last week culminated into a fracture this week,” Bank of America Corp. strategist Neha Khoda wrote in a note, adding that markets are now pricing in a recession.
Tariffs are expected to dent the growth of the world economy and fears are growing that the policies will lead to stagflation in the US. Junk spreads there widened by the most in six months this past week, but remain near historic lows, meaning they could move out significantly more if a recession hits. Some hedge funds have already stumbled as volatility rises and investors are piling into haven assets like gold.
“Underneath the surface, the angst levels have just gone up tremendously,” Victor Khosla, founder of opportunistic credit investor Strategic Value Partners, said in an interview with Bloomberg TV on Wednesday.
Here are five charts that highlight shifting sentiment in debt markets:
Junk Risk Premiums
With high-yield spreads in the US on the rise, Goldman Sachs Group Inc. strategists have already sharply raised their forecasts for the risk premiums as tariff risks increase and the White House flags that it is willing to tolerate short-term pain in an attempt to address the trade deficit. They now expect high-yield spreads to reach 440 basis points in the third quarter compared with 295 basis points previously. Levels as of March 13 were 335 basis points.
“Recently, we moved from a market that used to buy rumors and sell facts into a market that buys facts,” said Gauthier Reymondier, head of Bain Capital Credit Europe.
CDS Shift
Algebris Investments portfolio manager Gabriele Foa warned in February that high-yield credit default swaps, which protect against defaults, were trading at levels that had only been seen three times in the last 10 years and each time it was followed by a sharp widening in the six to nine months afterward. Fast forward to now and the Markit CDX North American High Yield Index, which falls when credit risk rises, has dropped to the lowest since August.
Private Markets Hit
The whipsawing of US economic policy is making it harder for private capital firms to sell off their holdings and many have added more expensive debt to their portfolio companies in response, much of it from private credit lenders.
At a conference in London this past week, a number of attendees spoke on the sidelines of concerns about interest-coverage ratios at private equity-owned companies, the risk that their firms are holding too much leverage and the need for direct lenders to diversify away from a possible overexposure to corporate credit.
“Too much money has flown into the private credit asset class,” said Claire Madden, a managing partner at Connection Capital, which invests in private funds. “We still haven’t had a cycle in a long time. There could still be a lot of problems down the road.”
Leveraged Loans Drop
A falloff in mergers and acquisitions was a plus for issuers in the leveraged loan market over the past year or so as yield-hungry investors snapped up any deals that came to the market, many of which were repricings. Money managers are now becoming more selective, pushing back on aggressive pricing and credits with lower ratings with five deals pulled from syndication in recent weeks.
Credit Outflows
The declines come even as inflows have generally been supporting credit prices in recent months, contributing to the tightness of spreads. But US leveraged loans saw their first outflows this year in the week through March 12, according to LSEG Lipper, while investors pulled money from high yield bonds at the highest rate in about two months. Of course, that might prove a blip if investors rotate into credit amid the equity market correction.
Still, debt markets are “going passive,” said Ted Goldthorpe, head of credit at BC Partners. “That’s not good” because when those funds become too big the market “becomes very flow oriented versus fundamental oriented.”
Click here to listen to the Credit Edge podcast with Goldthorpe of BC Partners
Week In Review
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Credit markets weakened globally this week as stocks sold off, amid escalating trade wars. A series of companies delayed bond sales in the US. Prognosticators from Barclays Plc to Goldman Sachs Group Inc. had to revise their spread estimates wider.
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Global banks appear to be giving top clients private information to win corporate-bond trading business, according to a new study showing the $56 billion-a-day market is stacked in favor of the most active investors with the broadest dealer networks.
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Investors are increasingly looking to profit from bets on recently-restructured European companies with high coupons, given spreads on high-yield bonds are near the tightest in years and there’s little in the way of fresh debt. Money managers are dubbing the trend “the dash for trash.”
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Rio Tinto Plc sold $9 billion of US investment-grade bonds, raising funds for its just-closed acquisition of Arcadium Lithium Plc.
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Elsewhere, Morgan Stanley has sounded out investors regarding a potential $4 billion debt package to refinance loans for Finastra Group Holdings Ltd.
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Ardagh Group is in talks with its creditors for a debt restructuring deal that would see Irish billionaire Paul Coulson lose control of part of the packaging company.
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A group of banks led by UBS Group AG launched a $1 billion debt package on Wednesday for energy-drink maker Celsius Holdings Inc.’s acquisition of Alani Nutrition LLC.
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Broadcast service provider E.W. Scripps Company has inked a deal with lenders to repay or extend about of its $1.3 billion term loans and secured a $450 million loan from investors including KKR & Co.
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Money managers that buy sophisticated bonds backed by US corporate loans are increasingly finding they have to not just pay attention to how companies are performing, but also how the US residential mortgage debt market is doing. Collateralized loan obligations have started looking expensive relative to collateralized mortgage obligations, which could limit future gains in CLOs.
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Deutsche Bank is increasing the size of a significant risk transfer linked to a portfolio of loans to German mid-cap companies, according to people with knowledge of the matter, in the latest indication of high investor demand for the asset class.
On the Move
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Bank of America Corp. promoted Neha Khoda to head of US credit strategy, a newly created role after the departure of high-yield credit strategist Oleg Melentyev.
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JPMorgan Chase & Co. hired mergers-and-acquisitions banker Jay Harris from Bank of America Corp. as Wall Street’s largest lender pushes to more thoroughly cover smaller and midsize companies.
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Canadian Imperial Bank of Commerce appointed Harry Culham to succeed Chief Executive Officer Victor Dodig, who will retire in November after leading the nation’s fifth-largest lender for more than a decade.
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HSBC Holdings Plc has appointed Alex Paul to lead its internal mergers and acquisitions team. Paul will be based in Hong Kong and start the new role next month.
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Deutsche Bank is hiring bond trader James Wilkinson from Goldman Sachs as part of its refocus on emerging-market credit.
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Millennium Management has tapped one of Eisler Capital’s most profitable traders to manage funds externally.
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Citigroup Inc. promoted Chris Cox to head of investor services as it pursues further growth in the services business following record revenues in 2024.
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Banco Santander SA has named Peter Huber as its new global head of insurance to replace Armando Baquero, who is exiting the Spanish lender.
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Goldman Sachs Group Inc. hired Citigroup Inc. veteran Tetsuya Oka to boost investment banking business in Japan.
–With assistance from Sonali Basak, Kat Hidalgo and Rheaa Rao.
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