After Rebound, Bond Bulls are $2.8 Trillion More Secure This Month

In November, global bonds rose to a record $2.8 trillion, as investors believed central banks were able to control inflation. However, it is not clear how long this party will last.

The market value for investment-grade corporate and government debt securities has risen to $59.2 trillion, from $56.4 trillion at October’s end. This is the largest monthly increase in a Bloomberg Index since 1990. After US inflation fell more than anticipated, the Federal Reserve signaled a slowdown in aggressive rate increases and buoying sentiment, the gauge rebounded.

Omar Slim, an Omar Slim fixed-income portfolio manager at PineBridge Investments Singapore said that “we are beginning to see a variety of economic indicators that point out the fact that inflation is peaked or peaking.” He said that while trading in US Treasuries will be volatile due to Fed rhetoric and economic data, the bond market rally “has legs”.

Since softer inflation data earlier in the month prompted a massive relief rally across all asset classes, reviving an asset class that was in its worst slump in decades. However, the possibility of recession is looming so a recovery will not be easy.

Goldman Sachs Group Inc. strategists expect US and European corporate bonds spreads to increase in the first quarter 2023, as central banks raise rates. Then they will tighten again to provide a soft landing for the US economy. They expect US investment-grade corporate bonds spreads to peak at 180 basis points, and end the year at 150 basis points.

In a note, Lotfi Karoui, a strategist at the bank, wrote that 2023 will see “low, but positive, excess returns” and “a much more pronounced improvement of performance” following this year’s historic plunge bond prices.

Investors in Europe are also betting on a better 2012, as spreads have fallen sharply. The yield premiums on euro-denominated corporate bonds are at their lowest point in six months. This is due to investors’ rush to get the best yields in a decade and optimism that rate hikes won’t slow down.

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UBS Group AG strategists predict that safer company debt in the common currencies will be a top trading option for next year. This asset class is expected to yield better returns than European stocks and German government bonds.

High-grade dollar spreads in Asia have grown less than their US counterparts this year. PineBridge’s Slim and others in the region believe that the region’s higher-rated credit, such as sovereigns or quasisovereign entities, like utilities, could be a potential opportunity going into 2023. This is due to their solid fundamentals.

He said that stronger growth in Asia, looser central bank policies in China and Japan and a substantial drop in dollar issuance in this region all support credit. However, investors need to be careful.

However, not all investors believe that recent gains are a sign of a lasting turnaround.

Nicholas Elfner is co-heading research at Breckinridge capital Advisors and is less optimistic about the US staying out of recession. He said that he is watching the yield curve’s inverted front end and the shape it is taking, which indicates investors are expecting a slowdown and that Fed policy may be too tight.

Elfner said that historically, high-grade credit spreads have reached a peak of around 175-200 basis point in a mild recession and 200-250 basis point in a full-blown depression. Elfner said that rates volatility may have peaked but credit spreads will not, depending on how the economic scenario suggests, he said.

Even if credit spreads increase in 2023, a nearly-tripling of global investment-grade corporate bonds yields over the past 12 months gives investor return a much larger cushion to absorb such an event.

Mid-December will bring the Fed’s final announcement for the year, which will be a crucial data point. For clues on the direction of the central bank and the implications for the bond market recovery, key payrolls and inflation data should be monitored before that date.

Steven Boothe, portfolio manager at T. Rowe Price Group Inc. and head of the fixed-income investment-grade fixed income team, said that “this hiking cycle will continue for longer than people expect.”

Boothe stated that November’s rebound was due to “market over hedged” and that it didn’t take much news (relatively good) to trigger the snapback rally. “I don’t think this will continue.”

Other credit markets:

EMEA

Three European issuers will tap Europe’s primary bond marketplace on Wednesday in order to raise at most EUR1.6 billion. Electricite de France is one of them, offering hybrid debt at an initial price discussion of around 8.25%.

• After a delay in a takeover by private equity groups, Atalian bonds suffered further losses. The two sides agreed that the exercise period for a put option would be extended to Dec. 16
• As part of deregulation efforts for London’s City of London, the UK will relax rules regarding banks’ ring fencing.
• Swedish landlord SBB is selling nearly $1 billion worth of properties to reduce debt. Around town, a real estate group, decided on Tuesday to skip calling a hybrid bond due to the high cost of issuing replacement bonds.

Asia

On Wednesday, Asia saw few dollar bond deals. China’s only notable issuer required a new offering. This reflects a greater caution in the market before Jerome Powell’s key speech later that day.

• Kasikornbank, a Thai commercial lender, will offer new sustainability-linked bonds denominated in yen and US dollars to domestic institutional investors next month, according to a regulatory filing.
• China’s cash-strapped developers of property are now ready to test investor demand. Policy makers have lifted restrictions on local share sale, and Shimao Group Holdings Ltd. plans to sell up 30% of the share capital of a key unit listed in China.
• A ruling from Nov. 28 stated that a court in Australia has rejected a request by Greylag Goose and two other leasing entities to wind down PT Garuda Indonesia.
• Credit traders reported that spreads on dollar investment grade notes in Asia ex Japan narrowed by at least 2 basis points on Wednesday. A Bloomberg index shows that they had already contracted this week to their lowest level since October early.

Americas

Amazon.com Inc. sold investment-grade bonds worth $8.25 Billion before inflation fears decreased investors’ desire for high-rated debt.

• El Salvador’s government has offered to repurchase its dollar bonds. This could be a relief to investors who are worried about the country’s ability to avoid default in the future.

• After easing inflation data earlier this month, and comments from Fed officials suggesting that it was time for interest-rate increases to slow down, US junk bonds are on track for another month of gains in this quarter.