Corporate Bonds Face Rising Risks as Market Volatility Spikes

Corporate bonds have stayed strong during a global government bond selloff, but that strength may soon fade as bond market volatility increases. Historically, this kind of uncertainty signals trouble for corporate debt when nervous investors pull their money out of the market. Right now, company profits are strong and higher yields partly reflect solid economic growth. However, as inflation pressure builds, the Federal Reserve is raising interest rates to slow that growth down. Over time, these higher rates can hurt the economy and squeeze profit margins. Kelly Kowalski, head of investment strategy at MassMutual, warned that longer periods of elevated and volatile yields make financial conditions more restrictive, weighing on economic activity and credit quality. JPMorgan Chase and Company strategists estimated that US high-grade corporate bond spreads should be about 0.07 percentage point wider than they are now. Yields across bond markets have jumped over the last month because oil prices climbed and inflation fears grew, with most benchmark US Treasuries now offering yields above 5 percent. Despite this, corporate bonds have largely shrugged off these moves. US high-grade spreads were 77 basis points on Thursday, which is two basis points tighter than at the start of the month. Money managers like pension funds and insurers often buy corporate debt when yields rise to fund future liabilities. Robert Tipp, head of global bonds at PGIM, noted that markets are used to rates rising in a controlled way when the economy is doing well, making shocks short-lived. Even so, investors are preparing for a potential slowdown. The ICE BofA U.S. Bond Market Option Volatility Estimate Index, known as the MOVE index, surged to about 105 basis points this week, which is its highest level since March and far above its ten-year average of about 80. Tom Murphy from Columbia Threadneedle Investments stated that yield-oriented investors want stable higher yields, but recent yields have been anything but stable. The cost of protecting North American credits against default using credit derivatives has also edged higher, with the CDX Investment Grade Index moving to around 58 basis points on Friday from roughly 55 basis points at the end of August. Climbing yields are already hitting corporate debt sales. US companies sold about $33 billion of bonds this week, which fell short of the roughly $40 billion forecast by dealers. Several borrowers paid about an extra 6 basis points to investors, order books shrank, and at least one issuer stepped back. Maureen O'Connor, global head of high grade debt syndicate at Wells Fargo, explained that issuers have become more cautious after the recent jump in Treasury yields. If yields stay high, companies will struggle to refinance, especially those rated in the lowest-trading CCC tier, as well as firms in private credit and software, according to strategists including Matthew Mish. Nachu Chockalingam, senior credit portfolio manager at Federated Hermes, added that companies now have to refinance debt that was previously at 3 or 4 percent at nearly double those rates.