Investment grade-rated corporates are the most vulnerable asset class in the credit market, with the decades-long bond bull run set to come to an end as central banks hike interest rates and unwind asset purchases, according to senior analysts.
“The punchline is that all our analysis points towards negative returns and higher volatility in the credit market,” says Viktor Hjort, global head of credit strategy at BNP Paribas. “Our view is that it’s late in the credit cycle. The riskiest asset class is actually non-financial investment-grade corporates as they are the biggest beneficiaries of quantitative easing (QE).”
“High yield should outperform because the businesses are naturally more cyclical,” says Mr Hjort. “The high yield market will also benefit from ratings upgrades. We are expecting €70bn of new rising stars from BB to BBB in 2022 in euro high yield.”
Just as central banks begin unwinding QE, non-financial corporates are set to ramp up the supply of new bonds in 2022 to a record $3tn of gross issuance globally, according to a forecast by BNP Paribas.
“There will be quite a substantial pick up in supply this year,” says Daniel Lamy, head of European credit strategy at JPMorgan, who expects around €645bn of issuance in euro high-grade credit this year.
“In 2021, we had a low level of high-grade issuance because of the amount of cash companies raised at the peak of the pandemic in 2020,” says Mr Lamy. “They had excess cash and so didn’t need to issue as much as last year. But this year, supply will increase and be driven by M&A, capex and inventory building.”
Calling the cycle
However, Mr Lamy disagrees with Mr Hjort’s view of the credit cycle. “I don’t think we’re late in the credit cycle but it could be a more accelerated cycle than the last one, where we had the economy held back by bank deleveraging causing low inflation,” he says. “The economy has a lot of room to grow.”
The increased supply will come as demand falls from lower purchases by central banks, which will cause spreads to drift materially wider.
Mr Hjort’s team predict the Bloomberg Barclays US and euro IG indices will reach 130 basis points (bps) and 140bps, respectively – a rise of around 30-40bps. This in turn will drive up new issue premiums for borrowers.
“New issue premiums were very low during 2021 but have begun to move higher this year,” says Mr Lamy. “We’re seeing deals come with 10-20bps of new issue premium and that’s happened in January despite the European Central Bank’s purchases not really falling off. “
However, this will not deter borrowers from issuing, according to Mr Hjort. “Supply indigestion is the main risk,” he says. “My guess is that a 10bps new issue premium is just nowhere near enough to make a dent on corporates’ willingness to issue bonds.”
The increased supply and lower demand dynamic will result in negative returns for the investment-grade corporate credit market in 2022.
“At the moment, investment grade returns are -1.5% year-to-date, but the asset class has only a 1% yield and we’re expecting higher rates, so it looks like we will end up with negative total returns for the year,” says Mr Lamy.
