Corporate bonds stage recovery after tough first half but outlook remains uncertain
An uncertain macroeconomic and geopolitical outlook means the corporate bond market is not out of the woods yet
An uncertain macroeconomic and geopolitical outlook means the corporate bond market is not out of the woods yet
The corporate bonds market had a tough first half of the year, as rising interest rates and inflation weighed on investor sentiment. Though the market has rallied since June, worries about slowing economic growth and recession mean investors will continue to exercise “intense pricing discipline “, according to Karl-Heinz Herweck, head of capital markets at Deutsche Bank.
Herweck says that following record corporate bond issuance volumes over 2020/2021, the first half of 2022 gave rise to a marked shift in market sentiment that impacted secondary market pricings of corporate bonds as well as new issuance activity.
“Investor demand waned due to rising rates and inflation, increasing recession risks, and geopolitical concerns, notably the war in Ukraine and China-US tensions,” he says.
According to data from Deutsche Bank, new issuance volumes in the US corporate sector plummeted 25% over the first half of the year versus the same period in 2021, with spreads widening and treasury yields spiking.
On the same basis, EUR corporate issuance volumes slumped 24%, with second quarter corporate issuance volumes for the region at their lowest since 2015.
Conversely, GBP bond volumes remained relatively stable, with a healthy split between UK/non-UK supply and diversification across sectors as the sterling market took advantage of certain arbitrage opportunities versus the euro.
“Despite the recent rise in rates and widening in credit spreads, funding conditions remain attractive from a historical standpoint in all major bond markets, although corporates are taking some time to adjust to the new cost of capital after record lows in recent years,” says Herweck.
In response to the weak performance over the first half of the year, investors are much more sensitive to pricing. This has led to a widening of spreads for issuers and increasing new issue concessions to incentivise investors to get involved in new bond sales, says Herweck.
“Investors are also putting more focus on the individual issuers’ credit, and we are observing an increasing spread differentiation between sectors and individual issuers,” he adds.
From the corporate perspective, Herwick says the overall cost of debt is going up and companies are responding to this by being more flexibility on issuance timing as well as pricing, spreads and new issue concessions.
Deutsche Bank has also seen experienced classical bond issuers looking to more alternative markets including, most notably, the EUR Schuldschein market, which saw record issuance volumes in the first half.
Schuldschein, a medium to long-term, unsecured debt financing solution with aspects of both loans and bonds, has been mainstream in Germany, Austria and Switzerland for many years. They are becoming an increasingly popular option among corporates beyond the DACH region. They tend to be less expensive than bonds and do not need to be listed or registered with a stock exchange.
Looking ahead to near-term prospects for the corporate bond market, Herweck expects that primary supply will continue to depend strongly on macroeconomic developments. In the meantime, he expects to see “a continuation of intense pricing discipline from [the] investor community”.
Herweck points out, however, that while funding conditions remain more difficult compared to recent years, with central banks having ended a decade of very loose monetary policy, the global bond markets have proven to be very resilient.
“There remains structural cash in the global fixed income markets that will continue to support corporate funding activity. While overall volumes will not reach the heights of recent years, we expect an ample amount of supply in the global corporate bond markets,” he says.
“We expect issuers to monitor opportunities in the bond markets (across currencies) and an increasing flexibility on timing and instruments selected.”
Deutsche Bank is recommending to its corporate issuers that they make full use of market windows as and when they open, and consider using alternative financing options, such as different currencies, the Schuldschein market and bank lending, to increase flexibility and optionality in their financing mix.