Investors in the $10.7 trillion U.S. corporate bond market are worried the delta variant of the coronavirus could dampen the economic recovery.
Bonds issued by oil-and-gas companies and those in travel and leisure have come under pressure as oil prices
tumble to three-month lows and investors worry about stepping in to buy at the wrong time.
“I think investors are saying: I’m going to see how delta plays out over the next couple of weeks,” said John McClain, a portfolio manager at Brandywine Global, adding that investors “want answers — and they want it immediately.”
As COVID-19 cases climb again, and U.S. hospitalizations and deaths rise, the Biden administration said it plans to administer 100 million booster shots of vaccines over the fall and winter to help end the pandemic faster.
Concerns about a geopolitical spillover from Afghanistan also have emerged, after the Taliban quickly rose to power as the U.S. withdrew, a decision President Joe Biden defended this week, saying that American troops shouldn’t fight or die in a war that Afghan forces are unwilling to fight for themselves.
McClain said the delta variant and Afghanistan were top of mind for investors, along with liquidity, which often dries up in late summer, even though this year new bond issuance hasn’t.
“For the most part, I think investors are taking a wait-and-see approach,” he said, even though he still sees bonds having “a lot of margin of safety” relative to the froth seen in stocks during the pandemic.
“Debt has grown, but equity market capitalization has grown faster.”
U.S. high yield, or “junk-bond,” issuance this year hit a record $333 billion as of Friday, up 21% from a year before, according to BofA Global Research. The junk-bond market has been heavily skewed to the oil-and-gas industry for years, but also serves as a home to other companies deemed a higher default risks.
Spreads were last spotted about 33 basis points wide of the July 1 lows of 302 basis points, according to the ICE BofA US High Yield Index. Spreads are what investors are paid in compensation above a risk-free benchmark, often Treasurys, to offset default risks. Those levels widen when investors demand more compensation to take on certain assets.
Liquidity in focus
While recent pressure on corporate bond spreads doesn’t come close to rivaling the stress of March 2020 when national lockdowns were imposed and liquidity dried up, investors pointed to a cloudier picture forming lately, even in lower-risk assets.
Corporate bonds with investment-grade ratings saw spreads widen recently from some of their lowest levels on record. Overall, spreads were about 94 basis points over Treasurys
at last check Thursday, after touching a post-2008 low in June of around 86 basis points, according to the ICE BofA US Corporate Index.
“The reopening trade is being beaten up a little bit,” said Terence Wheat, co-head of U.S. investment-grade corporate bonds at PGIM Fixed Income. “It’s the airlines, the hotels and the energy sector, with oil prices dropping with demand concerns, supply-chain issues and the delta variant.”
Even so, with spreads off the lows, Wheat’s team has been adding exposure, particularly in the BBB bracket that borderlines junk territory.
“Some of those are 20-25 basis points wider” from June lows, Wheat said, adding that his team still expects investment-grade spreads to end the year at slightly lower levels than at present, given the global hunt for yield and blockbuster second-quarter corporate earnings.
Unlike stocks, another factor has been investors viewing the Federal Reserve as a backstop for the sector, after it’s historic leap into buying corporate debt for the first time during the pandemic.
U.S. stock benchmarks have come under pressure this week too, trading off recent record highs, with the Dow Jones Industrial Average
off about 1.6% for the week through Thursday and the S&P 500 index
trading 1.3% lower for the same stretch, according to FactSet data.
“The big picture is that August seasonality factors in, with trading across all markets, including fixed-income and equities, seeing moves exacerbated,” said Mark Ruffalo, head of investment solutions at Clarfeld Citizens Private Wealth, in a phone interview.
“Growing concerns out of the Middle East could certainly have pretty large impacts on the market,” Ruffalo said. But he also thinks investors have grown pretty complacent, despite lingering uncertainties around the pandemic, the economic recovery and the forward trajectory of monetary support from the Federal Reserve.
“I think it’s complacency and a lack of alternatives,” Ruffalo said, pointing to the glut of negative-yielding bonds globally and stocks trading near record highs, but also the last notable U.S. equities pullback occurring some 10 months ago.
“Certainly, from our perspective, we want to be very flex and nimble because we think things could turn very quickly, in either direction.”