Europe’s high grade corporate bond market is on fire. Three borrowers have already priced benchmarks flat to or through fair value this week with ease. But in the background, the problems keep mounting, and it feels like just a matter of time before reality catches up to the exuberance.
Unilever, Statnett and Snam paid close to zero new issue concessions on Monday on €3.2bn of debt. Last week, P3 became the latest borrower from the beleaguered real estate sector to meet with an enthusiastic response in the primary bond market.
The secondary market is no slouch, either. The iTraxx Europe Main opened on Tuesday at 58bp, in line with where it was January 1 and down 3bp from 2024’s closing highs. The Crossover has widened by 7bp since the start of the year, an almost negligible amount for that index, and opened at 317bp on Tuesday.
At a glance, everything looks great, perhaps even exceptional, considering these feats are happening at a time of quantitative tightening.
But the arguments against such a powerfully strong corporate bond market are stacking up, and it is getting more difficult to ignore them.
A shelter from rockets
First, the biggies: the wars in Ukraine and Palestine are not going away and will likely only demand more serious attention from investors. This week has brought fresh alarm from the West — including open pleas for mercy from US president Joe Biden — as Israel starts air strikes on the city of Rafah in Gaza.
Neither war has been able to meaningfully shake Europe’s IG corporate bond market. But with the ebbing threat of escalation across the Middle East, notably after three US troops were killed recently by a drone strike in Jordan, there is a sense of unease that the West could be drawn in much further than it wants.
Earnings for the fourth quarter of 2023 gave some indication that the war is taking its toll on companies. For example, US fast food behemoth McDonald’s, which printed €2bn of debt in November, this month reported a quarterly sales miss, blaming weak growth in its international business division. The Israel-Gaza conflict was explicitly mentioned in the report as having made a meaningful impact.
This is the first time in more than three years that the company has missed a quarterly sales target.
Then there is the course of inflation. This is a battle it looks like the central banks are winning, but the market has shown itself far too willing to price in early interest rate cuts.
This is directly informing how investors approach deals, with duration finding the strongest bid so far this year as investors bet that rates will fall soon meaning this may be the final chance to lock in spreads and yields this high.
At the end of last year, markets were pricing in six rate cuts in Europe this year. European Central Bank president Christine Lagarde has thrown some cold water on this by heavily implying the bank will wait for the spring employment reports to guide on a rate cut, meaning summer looks more likely as a time for interest rates to start falling.
Meanwhile, the world’s election cycle rumbles on, with half of the world’s adult population voting this year. While market effects from voting outcomes have been localised for now, it is looking increasingly likely that the US presidential election in November will demand increasing attention. Over the weekend, likely Republican contender Donald Trump suggested that, under his watch, the US would not protect Nato allies that did not spend enough on defence. It’s not directly linked to corporate earnings and debt, but it’s another straw on the camel’s back to worry about in terms of geopolitical stability and economic confidence.
Get real, estate
Meanwhile, investors are becoming much more willing to take risks once again that they that were baulked at only recently. The real estate sector is slowly rehabilitating itself. Logistics companies and Vonovia have found success in the bond market so far but there is some debate as to whether companies that boast office blocks or shopping centres as assets would have had such a warm welcome.
Nonetheless, the deals that have come have gone brilliantly, and bankers say that companies from other sectors of the real estate industry are pressing them to see what they can achieve after two years locked out of the market.
This comes as there are murmurs in Germany that regional banks with high exposure to commercial real estate are being punished by fixed income investors, in the form of higher spreads. Another straw.
With all this weight bearing down, what’s holding the camel up? Unusually for something as complex as the corporate bond market, it seems to be just one thing — a surplus of investor cash.
Investors came into 2024 on the back of an unexpected late year rally that saw money flock to their funds. This means they had more cash than usual to put to work at a time when issuance levels have been standard, rather than high.
As long as the cash lasts, things will remain fine — it comes with a mandate to be invested in something. But it’s a finite resource battling against what often feels like a growing number of growing straws. It will be a small miracle if the camel can get through it without a spectacular collapse.