CREDIT FACES WORST YEAR SINCE 2008 AS STRAINS INTENSIFY / THE FINANCIAL TIMES

Credit faces worst year since 2008 as strains intensify

Redemptions from corporate bond funds rise amid gloomy performance for asset class

Adam Samson in London and Robin Wigglesworth in New York


Investors pulled more than $5bn from funds investing in corporate bonds in the past week, as the credit market heads for its worst year since the financial crisis a decade ago and concerns mount over the outlook for 2019.

Rising US interest rates, the Federal Reserve shrinking its balance sheet and the European Central Bank ending its own bond-buying programme have stirred worries over a new era of “quantitative tightening” that could rattle financial markets.

Corporate debt has emerged as one of the focal concerns, with Paul Tudor Jones, the veteran hedge fund manager, earlier this month predicting “some really scary moments” and even the Federal Reserve highlighting risks in its inaugural financial stability report this week.

US corporate bond yields have been climbing steadily higher this year, to an eight year high of 4.36 per cent on Thursday. That has inflicted a 3.9 per cent loss on investors so far in 2018, putting it on track for it the worst year for credit since 2008 and the fourth worst year since at least 1973.

After gargantuan inflows for most of the post-crisis era, investors are now tiptoeing out of corporate bond funds — especially riskier ones. Junk bond funds racked up outflows of $2.9bn in the week to Wednesday, according EPFR, a data provider. Redemptions have totalled almost $9bn over the past three weeks and nearly $65bn so far this year.

“Central bank liquidity has dried up,” said David Albrycht, chief investment officer of Newfleet Asset Management. He argued the economy is still in decent shape, but said that he had been “de-risking” his bond funds over the past year.

Investors have also shifted out of more highly rated investment grade corporate bond funds, which suffered outflows of $2.5bn in the past week. So-called intermediate-and-long-term funds have sustained year-to-date outflows of almost $34bn, although investors have shifted $8.9bn into funds holding shorter-maturity debt that is more resilient to rising interest rates.

The asset class “continued to face significant redemption pressure alongside further widening of corporate bond spreads,” said Kenneth Chan, Jefferies strategist. Higher spreads point to an increased perceived risk of holding corporate bonds.




In the large US market, corporate debt as a percentage of gross domestic product is at a record high, breaching even the previous top in 2008, according to Edward Marrinan, head of credit strategy for North America at HSBC.

He pointed out that the “bigger concern”, however, was the “degraded credit portfolio” of the US non-financial investment grade arena. About half of the debt capitalisation of a Bloomberg basket of the asset class carries a triple-B rating, according to Mr Marrinan, the lowest possible investment grade rung.

“In an adverse economic environment or in the event of an exogenous shock, we believe further downgrades to the constituents of this segment would present a serious challenge to the broader US dollar credit complex,” he said. “Hence, discretion is advised.”

Adding to the sense of gloom, Morgan Stanley told clients at the start of this week that the bear market in US credit is already under way. It said spreads had probably reached cycle lows in February.

The credit market faced headwinds this year from “weakening flows and tighter liquidity conditions” but has been propped up by a “solid” American economy, said Adam Richmond, Morgan strategist.

“In 2019, we think it gets tougher on both fronts — monetary policy will likely near restrictive territory for the first time this cycle, while the tailwind from a booming economy fades as growth decelerates and earnings growth potentially slows to a standstill,” he said.

This suggests risk that the market is late in the cycle, given the years-long recovery since the financial crisis, may “morph into end-of-cycle fears, continuing to break the weak links along the way, especially the more levered parts of corporate credit markets.”