(Bloomberg) -- Key measures of credit risk surged on Monday globally amid growing concerns of weakening economic growth. The turmoil effectively shut down US company bond sales on what had been expected to be among the busiest days of the year.
A gauge of perceived risk in the US corporate credit markets spiked as much as 7.4 basis points to 65.657 basis points Monday morning, the biggest-one day climb since March 2023, after Silicon Valley Bank collapsed. In Europe, the story was similar, with the region’s credit default swap indexes surging, reflecting greater perceived risk of companies defaulting.
Blue-chip companies that were looking to sell bonds in the US on Monday stood down amid the turmoil, according to debt underwriters. It would be only the second Monday this year with no investment-grade bond sales, excluding holidays, and with somewhere around 10 sales expected, would have been one of the busiest sessions of 2024 by number of offerings.
Late last week, Wall Street syndicate desks expected about $40 billion of US investment-grade bond sales this week, with about half the sales projected for Monday. It’s unclear when those sales will happen. In the leveraged loan market, SBA Communications Corp. on Monday postponed the repricing of a $2.3 billion loan slated to wrap up this week.
Corporate debt faces multiple headwinds now. Friday’s US jobs report implied that hiring is slowing faster than previously expected, raising recession concerns. Any economic weakness could make it harder for companies to pay their bills.
On top of that, the Federal Reserve is now seen as likely to cut rates more aggressively than economists had previously expected, which could make it cheaper for companies to borrow and spur more debt sales. Whenever Treasury markets settle down and corporations resume selling debt, the sales volume could be heavy, weakening corporate debt prices relative to Treasuries.
The upshot is that corporate bond prices will keep climbing, joining in a broader fixed-income rally as investors prepare for interest rates to fall. But credit products will probably lag Treasuries, as money managers demand higher yields relative to government debt to compensate them for default risk, pushing spreads wider.
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“The downside can be massive from these levels,” said Michael Contopoulos, director of fixed income at Richard Bernstein Advisors. “We expect spreads to continue to widen.”
In the leveraged loan market, commitments are due for more than 15 deals this week, including a handful of dividend deals and one acquisition. It’s unclear whether more deals will be delayed alongside SBA’s.
In Europe, an index that tracks credit default swaps for junk-rated companies jumped by the most since March 2023, when Credit Suisse collapsed. A credit derivatives gauge in Asia rose to the highest since May, and yield premiums for high-grade dollar bonds in the region are set for the biggest surge in 22 months, according to traders and a Bloomberg index.
The moves follow other asset classes in the throes of a wild correction, with a global stock rout still raging and a Wall Street stock market fear gauge, the CBOE Volatility Index, soaring to the highest since 2020. The concern is that the Fed has been behind the curve on rate cuts and that the world’s richest economy could be heading for a recession as a result. The timing of all this, however, is crucial because of the thin volumes that are typical throughout August.
In addition to coming to terms with the realities of an economic slowdown, “investors will also need to integrate uncertainty coming from the Middle East, with the risk of a broader war looming in the background,” said Raphael Thuin, head of capital market strategies at French asset manager Tikehau Capital. “This is a lot to digest for a month of August, at a time of tight spreads coming after an extended period of strong performance.”
Perceived credit risk had been falling for much of the year as investors chased elevated yields, and recession fears were put on the backburner, even though delinquencies have drifted higher. The default rate for Bloomberg’s European junk index climbed to 2.96%, crossing Covid era’s 1.8%. The latest gyrations suggest a turning point if concerns about a worse-than-expected slowdown in the US and its spillover effects deepen.
“The market was overdue a correction and there was too little differentiation between cyclical and non-cyclical credits,” said Thomas Leys, an investment director at Abrdn. “But clearly no one expected such a sharp reaction.”
Goldman Sachs Group Inc. economists on Sunday increased the probability of a US recession in the next year to 25% from 15%, while also adding there are reasons not to fear a slump, even after unemployment jumped. The economists expect the US central bank will reduce rates by 25 basis points in September, November and December.
“The current risk-off in credit will peter out,” predicts Bloomberg Intelligence Chief European Credit Strategist Mahesh Bhimalingam. “Credit metrics and quality are still quite solid and the central bank puts will soon be in action.”
--With assistance from Ronan Martin, Andrew Monahan, Hannah Benjamin-Cook, Taryana Odayar, Olga Voitova, Helene Durand, Wei Zhou, Michael Tobin and Olivia Raimonde.
(Updates with detail about expected bond sales from third paragraph and quotation in eighth paragraph)
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