Global credit markets just wrapped up their second consecutive quarterly win as buyers piled in, betting that the US could tame inflation while also avoiding a hard landing. The best first-quarter gains since 2019 follow the worst year ever for high-grade bonds, and the rest of 2023 looks increasingly challenging.

The crisis that toppled Silicon Valley Bank and Credit Suisse Group AG raised concerns about the stability of the global economy, just as recession odds rise while inflation remains stubbornly high. Tighter monetary policy meanwhile piles pressure on the riskiest companies by jacking up borrowing costs.

“The fastest rate hikes on record are bound to cause disruptions and dislocations,” said David Knutson, head of US fixed income product management at Schroders. “The market is not sure yet who will be left without a chair when the music stops.”

Even high-quality companies will struggle if households, concerned about the future, pull back on spending. That could create a negative feedback loop for credit, said Knutson.

“There is a lot of complacency about the risks that come from financial tightening,” said Gordon Shannon, portfolio manager at TwentyFour Asset Management. “Banks increasing lending standards, lending less, lending at higher rates and demanding more security – all of that translates into serious downside for the real economy.”

The good news is that most investment-grade companies are still considered to be in a relatively strong position with elevated cash levels to support them through a downturn. Some may well fall to junk – though not at the same pace as during the pandemic – but the higher duration characteristics of investment-grade bonds mean investors will benefit if the hiking cycle pauses or reverses.

“Given the combination of still elevated volatility and a likely decline in rates and steepening of curve over remainder of the year, our preference is for Asian investment grade,” said Todd Schubert, head of fixed-income research at Bank of Singapore.

But pressure is building on junk companies, which are forced to raise funding at higher interest rates, even as earnings are slowing. The premium the lowest-rated companies need to pay to issue new debt compared to high grade jumped in March.

“We’re already seeing some signs under the surface of levels of distress picking up in the credit market,” said Amanda Lynam, head of macro credit research at BlackRock, in a Bloomberg TV interview on Thursday. “The market is signaling that there is some concern now that’s largely concentrated at the low-quality end of the spectrum.”

Source: Yahoo Finance