Selling pressure: The site of the planned new London offices of JPMorgan in Canary Wharf, London. In the United States, the company says it does not believe that the strong spread performance is necessarily sustainable into the new year. — Bloomberg
WASHINGTON: Fear is drifting out of the corporate bond market again, even if the risks aren’t.
US high grade spreads touched 0.76 percentage point, their tightest levels since October and close to their highest valuation in decades.
They’ve been narrowing since late November. The cost of hedging in the North American high grade credit derivatives market has been declining in recent weeks as well.
But some investors and strategists see storm clouds ahead.
Heavy bond sales are coming to fund artificial intelligence (AI) investments next year, a factor that Barclays Plc strategists said could help drive overall US high grade bond sales to about US$1.6 trillion in 2026, up about 11% from this year.
Oracle Corp this week posted negative free cash flow for its latest quarter, and Bloomberg separately reported that some of the company’s data centre projects will take longer than it expected to complete, underscoring the risks that tech companies are taking now.
On top of that, there have been a series of big, debt-funded acquisitions in recent weeks that could further push up bond sales, including Netflix Inc’s agreement to buy Warner Bros Discovery Inc, a deal that could spur a bidding war.
More outsized takeovers could come next year, in part because companies think the US government under President Donald Trump is more friendly to such deals.
“We do not believe that the strong spread performance this month is necessarily sustainable into the new year,” strategists at JPMorgan Chase & Co wrote in a note.
Barclays strategists wrote that spreads on US high grade bonds would probably reach around 0.90 percentage point to 0.95 percentage point by the end of next year, thanks in part to selling pressure from companies.
A few factors are helping US corporate bonds now as new sales are likely to be minimal for the rest of the year.
That means buyers of the securities will have to purchase existing notes, which can help drive risk premiums lower.
Meanwhile, the US Federal Reserve cut rates last Wednesday, helped boost financial market liquidity – and securities valuations – broadly.
Also, companies across the credit spectrum are generally performing well from an earnings standpoint, said Hunter Hayes, chief investment officer at Intrepid Capital Management and who often looks at high-yield debt.
“When you look at the fundamental picture for the issuers of these bonds, it’s pretty healthy,” Hayes said.
But heavy debt issuance will probably return to the market in January, as is typical to start a year.
Just a few weeks ago, fears of that selling pressure were enough to push US high grade spreads to as wide as 0.85 percentage point on average, or 85 basis points.
JPMorgan said that massive investments from tech companies and others in AI would probably drive US$1.5 trillion of investment grade bond sales over the next five years.
Oracle’s recent weakness underscores how even if investors are broadly confident in companies’ ability to repay their obligations now, fear can emerge about particular firms.
Some of the high grade notes that Oracle sold in September are now trading more like junk bonds.
Paper losses on the US$18bil of bonds are now around US$1.35bil.
The company said it’s committed to keeping its investment grade status, and regarding its data centres, a spokesperson said there have been no delays to any sites required to meet contractual commitments and all milestones remain on track.
With valuations broadly so high already, it’s hard to argue that it’s the optimal time to buy, Barclays strategists said earlier this month.
“There’s very little upside potential offered from here,” they wrote. — Bloomberg
