Central banks will give risky debt a helpful shock

Higher government bond yields will end a post-pandemic boom in corporate debt, which investors snapped up in the last two years to have any hope of earning a return above inflation

  
Image used for illustrative purpose. The skyline with its banking district and the European Central Bank (ECB) is photographed in Frankfurt, Germany, August 13, 2019.

Image used for illustrative purpose. The skyline with its banking district and the European Central Bank (ECB) is photographed in Frankfurt, Germany, August 13, 2019.

REUTERS/Kai Pfaffenbach

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

LONDON - Corporate bond markets are entering new, dangerous waters. Major central banks are scaling back asset purchases, which is pushing up yields on benchmark government debt. The shock that will deliver to riskier debt may be no bad thing.

Minutes of the Federal Reserve’s December policy meeting suggested the U.S. central bank may stop buying bonds sooner than previously expected and allow its $9 trillion balance sheet to shrink for the first time since 2019. Meanwhile, the European Central Bank is starting to slow its asset purchases. U.S. and German 10-year government bond yields have risen over 30 basis points since early December. The latter are the least negative they have been since 2019.

Higher government bond yields will end a post-pandemic boom in corporate debt, which investors snapped up in the last two years to have any hope of earning a return above inflation. For example, U.S. high-yield funds added over $40 billion of assets in 2020, according to Deutsche Bank data. Outflows are more likely than inflows in the coming months. Inflation-adjusted yields on U.S. Treasuries have risen to around minus 0.79%, according to the Federal Reserve Bank of St. Louis, up from nearly minus 1.2% as recently as November.

Credit markets look vulnerable. The average extra premium that U.S. junk-rated debt offers over benchmark rates was 306 basis points on Jan. 12, according to Bank of America ICE indexes, around 1 percentage point less than the five-year average. The comparable spread for even riskier securities rated CCC or below was 659 basis points, more than 2 percentage points below the average for the same period.

Any selloff in corporate bonds is, however, unlikely to become a rout. The global economy is still growing, which will support corporate profits. And debt levels have fallen from their pandemic peaks: junk-rated companies had debt equivalent to around 5 times EBITDA at the end of 2021, down from nearly 6 times in 2020, according to Moody’s Investors Service.

The hunt for yield has seen investors accept ever looser lending terms in the last couple of years. Bondholder protections, which are designed to stop private equity funds siphoning off cash, are at their lowest level ever, Moody’s reckons. And borrowing on newly issued buyout loans totalled some 6.9 times EBITDA last year, a near record, according to Refinitiv data. An orderly shakeup is overdue, and will help curtail such potentially dangerous trends.

CONTEXT NEWS

- Yields on benchmark government bonds across developed markets have risen in 2022 because of expectations that central banks will dial back emergency stimulus.

- U.S. 10-year Treasury bond yields were at 1.73% on Jan. 13, up 22 basis points from the end of 2021. The yield on comparable German government bonds has risen 10 basis points over the same period, to minus 0.08%.

- The rise in yields was triggered by the publication of minutes from the U.S. Federal Reserve’s December policy meeting, at which officials discussed the possibility of reducing the amount of bonds held on the central bank’s balance sheet.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

(Editing by Swaha Pattanaik and Oliver Taslic) ((For previous columns by the author, Reuters customers can click on UNMACK/ SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS https://bit.ly/BVsubscribe | neil.unmack@thomsonreuters.com; Reuters Messaging: neil.unmack.thomsonreuters.com@reuters.net))


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