Europe’s investment-grade corporate bond market is on fire. Three borrowers have already easily priced stable or above fair value benchmarks this week. But in the background, the problems keep piling up, and it seems like it’s only a matter of time before reality catches up with the exuberance.
Unilever, Statnett and Snam paid no new issuance concessions on 3.2 billion euros of debt on Monday. Last week, P3 became the latest borrower from the troubled real estate sector to encounter an enthusiastic response in the primary bond market.
The secondary market is not left out either. The iTraxx Europe Main index opened at 58 basis points on Tuesday, in line with its January 1 level and down 3 basis points from 2024 closing highs. The Crossover widened by 7bps since the start of the year, an almost negligible amount for this index, and opened at 317 bps on Tuesday.
At first glance, everything seems great, perhaps even exceptional, considering that these feats come at a time of quantitative tightening.
But the arguments against such a powerful corporate bond market are mounting, and it’s becoming increasingly difficult to ignore them.
First, the most important: the wars in Ukraine and Palestine are not going away and will likely require more serious attention from investors. This week has brought renewed concern from the West – including open calls for mercy from US President Joe Biden – as Israel launches airstrikes on the Gaza town of Rafah.
Neither war managed to significantly shake the European IG corporate bond market. But with the threat of escalation fading in the Middle East, particularly after three US soldiers were recently killed by a drone strike in Jordan, there are fears that the West could be dragged much further than it does not wish it.
The results for the fourth quarter of 2023 suggest that the war is taking a toll on businesses. For example, the American fast food giant McDonald’s, which printed 2 billion euros of debt in November, reported this month a quarterly profit shortfall, attributable to weak growth in its international business division . The Israel-Gaza conflict was explicitly mentioned in the report as having had a significant impact.
This is the first time in more than three years that the company has failed to meet its quarterly sales target.
Then there is the course of inflation. It appears that central banks are winning this battle, but the market has been far too willing to price in early interest rate cuts.
This directly impacts how investors approach trades, with duration being the strongest bid so far this year as investors bet that rates will soon fall, which could be the last chance to lock in spreads and yields at such a high level.
At the end of last year, markets were expecting six rate cuts in Europe this year. European Central Bank President Christine Lagarde threw some cold water on the matter by suggesting that the bank would wait until spring employment reports to decide on a rate cut, meaning that summer seems more likely as a time for interest rates to start falling.
Meanwhile, the global election cycle continues, with half of the world’s adult population voting this year. Although the effects of the election results on the market are localized for now, it seems increasingly likely that the US presidential election in November will require increased attention. Over the weekend, likely Republican nominee Donald Trump suggested that, under his leadership, the United States would not protect NATO allies that were not spending enough on defense. This is not directly related to corporate profits and debt, but it is another drop on the camel’s back to worry about in terms of geopolitical stability and economic confidence.
At the same time, investors are increasingly willing to take risks, unlike those they were recently reluctant to take. The real estate sector is slowly rehabilitating. Logistics companies and Vonovia have so far enjoyed success in the bond market, but there is debate over whether companies with office buildings or shopping centers as assets would have received as warm a reception.
Nonetheless, the completed deals have gone brilliantly and bankers say they are being pressured by firms in other parts of the property sector to see what they can achieve after two years of being out of the market.
It comes amid rumors in Germany that regional banks with heavy exposure to commercial real estate are being punished by bond investors, in the form of higher spreads. Another straw.
With all this weight, what is holding the camel back? Unusually for something as complex as the corporate bond market, it appears to be just one thing: excess liquidity for investors.
Investors arrived in 2024 following an unexpected late-year rally that saw money flowing into their funds. This means they had more cash than usual to use at a time when emission levels were standard rather than high.
As long as the money lasts, everything will be fine: it comes with the mandate to invest in something. But it’s a finite resource battling what often feels like a growing number of straws growing. It would be a small miracle if the camel could escape without a spectacular collapse.