Corporate debt investors brace for tighter financial conditions in 2022

Low borrowing costs have been a silver lining for big American businesses during the pandemic, giving the farthest corners of the business world a lifeline when it was needed most.

But as Federal Reserve officials debate how quickly to reduce hugely accommodative monetary policy measures as the US economy recovers from the depths of the COVID crisis, corporate debt markets in 2022 could have bumps. on the road.

“Usually when the Fed eases things are really good and credit is doing well,” Michael Collins, senior portfolio manager at PGIM Fixed Income, said in a telephone interview.

Fixed income yields in 2021 have been low, as has the volatility of corporate bond spreads for the most part, which helps keep credit sufficient and flowing to U.S. corporations.

The spread, or premium, that investors earn on LQD-grade U.S. corporate bonds,
+ 0.22%
went to nearly 101 basis points above TMUBMUSD10Y risk-free treasury bills,
Black Friday as concerns mounted over the omicron variant of COVID-19. Although still historically low, it was the highest level since March for the sector, according to CreditSights, while high yield HYG bonds,
spreads increased by almost 40 basis points, considered the biggest move of the year.

See: Biden says fight against omicron variant of coronavirus won’t involve ‘shutdowns or lockouts’

But when the Fed begins to reduce its support in the coming months by reducing its monthly bond purchases, and later by raising interest rates, Collins expects a more difficult environment for risky assets like corporate bonds.

“The likelihood of a risk-free event is higher as public and private debt are higher,” Collins said, noting the increase in borrowing from the US government and large corporations.

To this end, PGIM Fixed Income has eased into longer-term corporate bonds and kept dry powder until 2022, to potentially add exposure to wider spread levels in a sell scenario. massive.

Better credit

Like homeowners, many American businesses have used pandemic low rates to borrow more cheaply or to refinance more expensive debt. Despite the explosion in corporate debt over the past decade to over $ 10 trillion, strong corporate profits in recent quarters have helped improve the credit profile of many companies (see chart).

American companies are more in debt than ever


The chart also shows the level of corporate distress falling by more than 40% so far in 2021, with defaults in the riskiest high yield bonds, or “junk bonds,” JNK,
category has recently headed for all-time lows.

“The leverage is down because EBITDA is up, but debt levels are high,” Collins said, speaking of the popular measure of corporate financial health, or earnings before interest, taxes, depreciation and amortization. “It is really expensive to pay off this debt at higher interest rates,” he said. “I think this is something the markets will struggle with over the next 12-24 months.”

Always something ‘

The liquidation and recovery after Thanksgiving is a reminder that uncertainty over the trajectory of the pandemic remains a threat to public health and markets after nearly two years. Fed Chairman Jerome Powell, nominated for a four-year second team, has frequently said the pace of the recovery in the United States and the central bank’s response will depend on the virus.

Many strategists predicted tighter financial conditions over the coming year, but also continued the global economic expansion. Oxford Economics has a 4.5% forecast for global GDP growth in the coming year, but also a downward scenario of 2.3% growth if the omicron variant causes “serious side effects” , in particular a reduced efficacy of the vaccine.

Kathy Jones, chief fixed income strategist at Charles Schwab, noted that key rates have already “started to rise in major emerging markets in response to rising inflation and steep currency declines.” its outlook on fixed income.

Beyond the massive sell-off triggered by omicron, high levels of inflation in the United States and bottlenecks in the supply chain remain the main concerns for investors, but also the possible hike in US policy rates by the current range of 0% to 0.25%.

“There is always something you can’t see,” said Greg Staples, head of fixed income for the Americas at DWS Group, in a telephone interview.

But even with an uncertain backdrop for 2022, Staples said DWS remains constructive on U.S. business credit. “In high yield the fundamentals are really strong, with defaults around the 2% level, and could drop below 1% which is unbelievably low,” he said.

Specifically, energy companies have benefited from rising oil prices, with US benchmark West Texas Intermediate crude futures CL00,
nearly $ 70 a barrel, up 46% over the year until the end of November.

Read: Oil could reach $ 150 a barrel with OPEC + “in the driver’s seat”: JP Morgan

“It is still the weak sister of the high yield bond market,” Staples said, adding that while energy still accounts for a large portion of the US high yield bond market, many companies have used the “open window. “easy financing during the pandemic to reduce coupons and extend deadlines.

“It won’t be an explosive year ahead, but there will be some positive feedback to be had,” he said.

Carol M. Barragan