Hold on to your hats: 2024 will bring not one new paradigm but two

Even those old enough to have been working in capital markets during the last interest rate raising cycle can now barely remember it. But the notion that central banks hiking rates aggressively, as they did in 2023, would lead to heavy spread widening seemed like common sense.

To the surprise of many, this did not happen. After starting the year at 90bp, the S&P iTraxx Europe Main index of credit default swaps was at 71bp on November 14. Only on two days in March did it close above 100bp.

“By the final quarter of 2023, investment grade was better than you would have expected nine to 12 months earlier,” says Giulio Baratta, head of debt capital markets corporates, EMEA, at BNP Paribas in London. “This was the year of tapering, and credit spreads have been remarkably resilient.”

Despite this, corporate borrowers were sparing in their use of the market. Some €283bn of high grade corporate bonds were issued in euros up to the middle of November, according to Dealogic. While that was more than the €262bn printed in all of 2022, it was still well off the €350bn pumped out in 2021, let alone the €454bn record in 2020.

Some had headed into 2023 full of hope. “2022 was a horrible year for everyone in credit — when 2023 started, everyone was 100% sure that it was going to be a great year for fixed income,” says Gabriele Foà, co-portfolio manager for the Algebris Global Credit Opportunity Fund. “It was, until May. Then rates started moving up.”

The relentless rise in rates across the West has had a widespread impact on the market and the corporate sector. Companies have held off on takeovers and capital expenditure, and hence curbed the debt issuance to fund what looked more and more like extravagances.

Heading into 2024, the messaging from the European Central Bank, US Federal Reserve and Bank of England has changed from ‘we will do what it takes to beat inflation’ to ‘we can go steady but it will be higher for longer’.

That means market participants expect 2024 to be another fallow year for issuance (see graph). Of 22 bankers and investors surveyed by GlobalCapital, only a plucky 27% think volume will be higher than in 2023 — though none are optimistic enough to think it will grow by more than 20%.

Researchers at ING predict 2023 to end with €290bn of euro corporate bond issuance and expect it to expand slightly to €310bn in 2024.

But this will be driven partly by a rise in redemptions, from €246bn to €260bn. If ING is right, net issuance will edge up only slightly, from about €45bn to €50bn — keeping it at the slow pace it has held since 2022.

That is a huge change from 2018 to 2021, when there was between €130bn and €250bn of net issuance every year.

Other firms think net issuance could even go negative in 2024. “It could be a year of lower net issuance,” says Baratta at BNP Paribas. “Companies will continue to be cautious with their business plan expenses and will come to the market if they have a strong business need.”

Deals are likely to be unambitious in maturity. Most issuers are loath to lock in long maturity bonds at such high rates. However, going too short on duration would give them refinancing headaches sooner than they would like.

“You need to try to refinance in the most cost-efficient way, but also avoid maturity walls, which means the medium part of the curve will be best for cost effectiveness,” Baratta says.

Whether borrowing ends up higher or lower, there is a widespread consensus that spreads will move higher, shared by an emphatic 90% of respondents in our survey.

Of those, 36% think spreads will widen by 20% or more. That implies a Main index in the low 90s at least and a Crossover flirting with 500bp.

None of those surveyed think spreads will tighten, though 9% reckon they will stay roughly flat.

“IG doesn’t pay a large amount of spread,” says Foà at Algebris. “It’s super-hard to beat cash in a situation where cash pays 4% to 5%. Spreads of 60bp, 100bp, even 150bp are not worth it because of cash. Taking 5.5% for five year IG corporate risk makes no sense.”

But although market participants are getting their heads round the higher-for-longer rates scenario, which they expect to bulk large in 2024, everyone surveyed also agrees that it will come to an end — rates in Europe will start to fall within the year.

“There is already data showing economic slowdown in Europe and parts of Asia, so 2024 will be an environment for lower rates but spreads will be a bit higher,” Foà believes. “A lot of companies that need to refinance will have to pay coupons that are substantially higher. There are opportunities going into 2024, but it’s going to be very important to differentiate between various credits.”

So far, the pain of the cycle has fallen much more heavily on some industries. Large swathes of property companies were shut out of the bond market in 2023 as investors shunned them, scared of their exposure to rates, the damage to retail from online shopping, and the long-lasting social change of working from home.

Only a handful of real estate issuers rated below A- issued bonds in 2023, and investors remain jittery. In early November, Carmila, Europe’s third largest listed shopping centres group, rated BBB, sold a €500m 5.5% October 2028 bond 128bp wider than where same-rated Portuguese energy company EDP had printed a €600m 4.125% April 2029 bond just days earlier.

This wide differential suggests investors do not yet believe real estate is past its many problems. Our survey confirms that: 37% of respondents think conditions are going to get worse for real estate borrowers in the capital markets in 2024 — as many as think they will get slightly better.

Other sectors look ripe for difficulties. Respondents were unanimous that cyclical sectors that rely on discretionary spending would be out of favour in 2024. Industrial cyclicals such as the chemicals sector were repeatedly highlighted as a potential source of pain, as was retail discretionary.

“The higher for longer slogan in Europe means we do not believe that rates are going higher than they are today,” says Baratta at BNP Paribas. “This means that yields are probably at the top end, but spreads could remain volatile. Because there is not a significant maturity wall in 2024, I don’t think there will be a single sector that is more stressed than others, but cyclical businesses are naturally more exposed to volatility.”

Market participants are bearish on some deal structures, too. Sustainability-linked bonds have fallen out of favour in the past two years. European companies issued just €24bn-equivalent up to November 8, according to Dealogic, compared with €40bn in 2022 and €47bn the year before.

Investors have lost enthusiasm for them for reasons both mechanical — they don’t sit neatly in Article 9 funds under Europe’s Sustainable Finance Disclosure Regulation — and qualitative: they question whether companies are ambitious enough in their sustainability targets.

Another commonly raised concern is whether the market standard 25bp coupon increase for missed targets, which was introduced in an age of zero and 1% coupons, is still appropriate when coupons can be 5%.

Some 73% of our respondents think SLBs will not make a comeback in 2024, with another 22% expecting there to be less issuance. Only one bold respondent thinks there will be more SLBs.