Credit Investors Are Getting Ahead of Themselves

(Bloomberg) — Editor’s Note: Welcome to Credit Weekly, where Bloomberg’s global team of reporters will catch you up on the hottest stories of the past week while also offering you a peek into what to expect in credit markets for the days ahead.

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This week’s market turbulence aside, corporate-bond buyers have been cruising toward the biggest quarterly gains since 2020’s pandemic rebound.

It’s a peculiar rally. The Treasuries market is warning of an almost certain recession in the US. And the European Central Bank acknowledged this week that a shallow economic slump has probably already begun. Now even some of the most sanguine market observers are warning that investors have gotten ahead of themselves.

To understand the concern, consider yield spreads on US investment-grade corporate bonds. During each of the past three US recessions, that measure soared to more than 200 basis points over Treasuries, Bloomberg index data show. The closest it got this year was 165 basis points, and it has since slid back to 131.

It’s the same for US junk bonds, the debt that’s most vulnerable to a downturn. Their spreads are averaging just 445 basis points, compared to recession-era peaks of at least 900.

To be sure, credit strategists are largely projecting that credit markets will end 2023 on a high note. But many see more pain before then. As MM Warburg & Co.’s Martin Hasse told Bloomberg’s Tasos Vossos this month: “The entry point will be better in the second half. The market does not price in risks related to recession and we see a widening of spreads in the first half.”

China Strains

China’s increasingly apparent pivot from Covid Zero is prompting investors to bet on a reopening by shifting money out of fixed-income assets and into riskier investments like stocks. But the rush of cash out of China’s domestic bond market is now putting a key corner of the country’s financial system at risk.

Retail investors are pulling money from so-called wealth management products (WMPs) that buy bonds and other relatively safe assets. The exodus has triggered one of the steepest selloffs in the domestic market since 2015. And because WMPs are one of the primary buyers of bonds issued by local government financing vehicles — entities that in recent years played a crucial role in funding China’s roads, bridges and subways — the selling is also straining that $1.6 trillion pile of debt.

The bond-market pressure this week prompted Chinese regulators to ask the nation’s biggest insurers and lenders to buy bonds offloaded by WMPs using their own balance sheets, following a similar request to large insurers the previous week.

China’s onshore bond market may face selling pressure totaling 497 billion yuan ($72 billion), brokerage firm Shenwan Hongyuan Group Co. estimated, based on what it called an extreme scenario.

Discretionary Pain

Pandemic-era stimulus checks and ultra-low interest rates provided a tailwind to even some of the most vulnerable consumer goods companies the past two years. But this week brought a reminder of just how quickly fortunes can fade.

Labeyrie Fine Foods SAS, a French purveyor of foie gras, smoked salmon and other fine foods, has warned investors that it will likely need to draw on loans to make up for dwindling cash buffers as inflation drives up production expenses and squeezes household budgets, Bloomberg News reported.

Meanwhile, Wheel Pros, a Clearlake Capital Group-owned company that makes custom car wheels, said in a private disclosure to investors that its earnings dropped nearly 86% from a year earlier, sending the price of its bonds to 25 cents on the dollar. And mattress-maker Serta Simmons Bedding was said to be preparing a bankruptcy filing as soon as January as all of its $2 billion-plus debt load matures next year.

Elsewhere:

Elon Musk’s decision to sell another $3.6 billion of Tesla shares is fueling speculation that the billionaire may be preparing to buy back some of the costly debt that he loaded onto Twitter when he acquired the social media platform
With US property prices declining and interest rates soaring, it’s getting harder to refinance commercial mortgages. That’s set to pressure about $34 billion of commercial mortgage bonds coming due in 2023
The biggest lenders in private credit are getting even bigger as a worsening outlook makes investors pickier about where they park their cash. Half of the $172 billion raised in the first three quarters of the year went to the top 10 funds
India’s biggest pension fund has resumed investing in rupee bonds issued by top-rated private companies as large inflows push it to look for newer avenues to deploy cash
There are plenty of reasons why bankers won’t miss 2022, but here’s one more: about 140 debt offerings — bonds, loans and asset-backed securities — worth at least $75 billion were pulled this year. That’s only marginally below the combined total for the two previous years, data compiled by Bloomberg show

–With assistance from Dana El Baltaji, Lorretta Chen, Catherine Bosley, Tasos Vossos, Giulia Morpurgo, Erin Hudson, Rachel Butt, Wei Zhou and Dorothy Ma.