Global Economy’s Strength Masks Growing Concerns
As the global economy continues to show resilience, asset managers are pouring money into the market, driving credit spreads to near all-time lows. However, beneath the surface, there are warning signs that suggest it may be wise to hedge one’s bets.
Corporate Bond Shorts on the Rise
According to data compiled by S&P Global Market Intelligence, corporate bond shorts have increased by 25% to almost $336 billion over the past year, while institutional longs have risen by 10.6% to $4.6 trillion. This shift in sentiment is notable, as it suggests that investors are becoming increasingly cautious about the market’s prospects.
Valuations Reach Extreme Levels
Zachary Swabe, a high-yield portfolio manager at UBS Asset Management, notes that large inflows into high-yield bond funds in the US and Europe are causing spreads to grind tighter. “If valuations are screening extremely tight, shorting bonds can be highly profitable,” he says. With credit spreads hovering around 30 basis points above their all-time lows, some investors are taking advantage of the opportunity to hedge their bets.
Economic Concerns Linger
Despite the strong economy, there are concerns about US fiscal policy, which is deemed unsustainable by economists at Apollo Global Management. Additionally, S&P 500 earnings misses are on the rise, and funding costs in overnight repo markets are increasing at an alarming rate. Furthermore, Germany’s economy remains sluggish, and China’s growth has yet to gain momentum despite stimulus efforts.
Hedging Strategies
Investors may be shorting corporate credit as part of a broader hedging strategy to offset long positions in equities or other assets sensitive to debt conditions. Market makers at banks are also borrowing bonds to sell to asset managers, effectively leaving dealers short until they can buy the debt.
Credit-Default Swap Indexes
Credit-default swap indexes covering junk-rated companies in Europe and North America have not tightened as much as the spreads of bonds they insure against. This disparity suggests that investors are hesitant about the state of the market, and shorting securities could pay off if the economic picture suddenly darkens.
Week in Review
Companies are rushing to sell bonds and loans before markets slow down around Thanksgiving and the December holidays. US high-grade corporate bond sales have reached the second-highest level on record, while nearly $185 billion of US collateralized loan obligations have been issued this year, setting an annual issuance record for the third time since 2018.
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