Corporate bonds are primarily driven by interest rates and risk premiums (spreads). The former are clearly supportive in a context of falling rates, but what about spreads? At 0.99%, they are at their lowest, but sectors that could suffer from a fall in consumer spending are enjoying a series of successes with their new bonds.
Volkswagen, for example, which is preparing to close factories in Germany and cut tens of thousands of jobs, had no problem issuing €2.75bn, and its order books even exceeded €11bn. In the luxury goods sector, Kering and Burberry had no trouble attracting investors despite a slowdown in Chinese demand. The real estate sector, one of the beneficiaries of lower interest rates, is also benefiting. Citycon, the Finnish property company that had to make a costly swap of its hybrid debt at the end of May to save its BBB- rating, was the best performer on a new bond issued in December. The return to favour speaks for itself: the €350mn issue of a new green bond attracted €3.6bn in demand. Moreover, by 11 December, the spread on all new issues during the month had tightened.
The market's appetite can also be seen in the performance of speculative credits. The lowest quality (CCC-D) is up more than 24% this year, compared with 10.5% for the B rating and 8.3% for BB. And while the 4% rise in the ‘investment’ category looks weak by comparison, credit is on a roll.
But the reason for these performance is technical. While some feared that more restrictive central banks would lead to a decline in liquidity, this is not the case.
According to Morningstar, October was the best month for European bond fund inflows since July 2019 (€42bn). Over the year, inflows reached €300 billion, more than double the amount for equity funds.
These flows are fueling the new issuance market, which has already broken its all-time record: over €635bn was issued as of 3 December. This support is making the European bond market immune to volatility, but it is also prompting investors to resume the hunt for yield. Indeed, demand for perpetuals and lower-rated bonds is rising thanks to the significant differential in yield between senior and subordinated debt.
According to Bloomberg data, it stands at 2.7% for a 2030 maturity/early redemption. Senior financial bonds yield 3.3%, while subordinated debt (AT1) from the same issuers yields ... 6%.
The European credit bond market illustrates one of the first lessons of finance: excess demand. The next step is to fine-tune selection in order to limit risk in the event of a reversal in buying flows. Until then, the market should continue to benefit.
