From Sydney to Washington to Ottawa, central bankers are reiterating their commitment to wrestling inflation under control. But skeptic market participants have been on the lookout for weakening resolve that could derail them from that objective.
According to Canso Investment Counsel Ltd.’s Corporate Bond Newsletter for October 2022, this dynamic resulted in unsteady financial markets that wavered between central bank announcements and economic releases.
“Simply put, there was no obvious place to hide as all asset classes suffered,” the newsletter says.
“The carnage in fixed income markets is the worst seen in most of our lifetimes… (but) leveraged loans continued to be resilient and were once again at the top of the table.”
Among these is Morningstar/LSTA U.S. Leveraged Loan Index, which produced a 1.03% return in the third quarter, despite falling -2.27% in September.
“However, (leveraged) loans are down by 2.25% for the year through October, leaving 2022 on track for the worst annual return since the Global Financial Crisis,” reported Marina Lukatsky, leader from S&P Global Market Intelligence LCD Research business, in the October Morningstar/LSTA analysis.
“Investors in high quality bond markets in Canada also found refuge amongst the wreckage in the third quarter (and), despite the move in short yields, longer term government bond yields in Canada finished the period largely unchanged,” Canso says.
Rising interest rates and market lurches also resulted in a heightened cost of borrowing.
“Borrowers across industries tapped the corporate bond market in the early days of the pandemic to bolster their cash reserves to protect from uncertainty,” reads the newsletter.
Some companies like Delta Airlines and Suncor Energy, which benefited from strong recoveries, were able to use debt tenders to “pay down high coupon debt prior to maturity, (and) save significant interest costs in the years ahead.”
Meanwhile, Rogers, which issued over 10 billion dollars worth of bonds in March with a “Special Mandatory Redemption” (SMR) clause redeemable at 101 cents on the dollar, saw itself in hot water after bond prices fell, following the sharp rise in interest rates.
“By August, longer-dated bonds were trading down in the low $90s-range making the 101 SMR clause quite attractive for bondholders, and quite punitive for the company.”
Rogers ended up having to push the SMR date out a year, and pay hundreds of millions in fees.
High yield credit markets were also volatile during the third quarter. Starting at 605bps in early July, spreads sank to a low of 443bps.
“Renewed attention on monetary policy coupled with recession concerns pushed spreads to 550bps at quarter-end,” the newsletter says.
“Volatile market conditions and the rise in yields continued to translate into limited new issuance…Issuers needing to complete transactions face significantly higher funding costs and a skittish, often non-committal investor base.”
Canso foresees all of this translating into less money available for lower quality companies and at much more expensive rates.
“We expect this dynamic to lead to more corporate defaults. So while lower quality credit is looking more interesting, with high yield credit spreads hovering around their historic average and default rates still low, the stress being observed may just be the start.”
The best way to take advantage of these market conditions, Canso says, is by “concentrating research efforts on new issuers that may become interesting as credit markets continue to tighten, (and) placing relative value in higher quality and highly liquid securities, which will be saleable in the worst of market scenarios.”
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