Finbarr Flynn, Garfield Reynolds and Colin Keatinge
Sun, October 2, 2022 at 11:07 PM·7 min read
(Bloomberg) -- Governments and companies around the world are facing unprecedented costs to refinance bonds, a burden that’s set to deepen fissures in debt markets and expose more vulnerabilities among weaker borrowers.
A corporate treasurer or finance minister looking to issue new notes now would likely have to pay interest that’s about 156 basis points higher on average than the coupons on existing securities, after that gap surged to a record in recent days. That all adds up to about $1.01 trillion in additional costs if all those securities were refinanced, according to calculations using a Bloomberg index tracking some $65 trillion of government and corporate debt across currencies.
That broad benchmark of global debt lost 6.8% last quarter, its second-worst drop after a record slide in the previous three months, data stretching back to 1999 show. Monday brought little relief, with spreads on Asian high-grade dollar bonds little changed after blowing out the most in six months last week.
Rolling over debt is proving increasingly tricky for weaker borrowers as creditors price in risks of a global recession. Most governments and companies are still able to stomach the higher financing bills, but soaring fund outflows and volatility are causing credit markets to start to buckle. Banks last week had to pull a $4 billion leveraged buyout financing, and even investment-grade debt funds suffered one of the biggest cash withdrawals ever.
Actual overall refinancing costs will depend on where rates are when borrowers do roll over debt, and of course many with longer-term obligations won’t need to do so anytime soon. Still, with the Fed expected to raise its target rate more than a percentage point before year’s end, there’s also a risk borrowers could face even higher costs if they hold off.
Central banks must walk a fine line as they fight some of the worst inflation in decades, with Bank of America Corp. strategists recently warning that the Federal Reserve needs to slow the pace of rate hikes to prevent credit market dysfunction.
Concerns are also growing that liquidity is draining out of the world financial system as interest-rate swaps -- one of the world’s deepest markets -- fluctuate wildly. The gap between the floating- and fixed-rate legs of longer-dated swaps tied to the US Secured Overnight Financing Rate swung in some recent days by the most on record for the index, which was rolled out in October 2020 as a replacement for the London interbank offered rate.
Six US-based borrowers tracked by S&P Global Ratings defaulted in August, as signs mount that higher rates are already taking a toll on stretched borrowers’ ability to keep issuing new debt to pay off old. Other examples of debt stumbles abound, including in Asia where Sri Lanka defaulted on its borrowings earlier this year, and Chinese property firms have suffered record nonpayments.
“The era of cheap money is certainly over,” said Neil Shearing, group chief economist at Capital Economics. “We are at the start of a global recession in our view and that includes a recession in Europe, which is particularly weak.”
Fed bankers dispelled in recent weeks any suggestion they are near halting interest rate hikes even if it means pain for the economy. That’s even after embarking on one of the most aggressive hiking cycles in modern times and their third consecutive 75-basis point interest rate increase in September.
The Bloomberg Multiverse Index of investment-grade and high-yield bonds across currencies has lost about 20% this year, on track for its worst annual slump ever. The securities fell into their first bear market in a generation in September.
Frontier sovereigns and highly-leveraged companies that borrowed in foreign currencies face potentially the greatest stress, according to Shearing at Capital Economics. While different in nature, the recent turmoil in UK markets after the government there announced dramatic tax cuts is a “warning” to other governments that they have less room for fiscal maneuver or policy error now, he said.
Higher borrowing costs are pinching even the strongest corporations too. The difference between current yields and average outstanding coupons for both US and European borrowers is currently around the highest in more than a decade. A sudden chill in US primary markets coinciding with the latest leg higher in yields is evidence that borrowing at current levels is becoming an increasingly unattractive proposition.
“We expect the cost of financing to rise gradually as companies refinance debt with higher coupons as more debt matures over time,” Barclays Plc credit strategists Zoso Davies and Jenny Avdoi wrote in a note dated Sept. 30.
The Fed’s hawkishness is also complicating the task for borrowers because it’s sending the dollar surging to multi-decade highs against many of its major peers, including the euro and the yen. That can push up costs for non-US issuers that need dollar financing, as well as tightening financial conditions around the world.
“Investors had reported record amounts of cash in our most recent quarterly surveys, but recent trading activity suggests an increase in client selling perhaps in part driven by the need to raise additional cash for anticipated redemptions,” emerging-market strategists including Donato Guarino at Citigroup Inc. wrote in a recent report. “In other words, the cash cushion may be diminishing, making any further market jolt more damaging to asset values.”
The average yield on corporate bonds globally across currencies and ratings recently topped 6% for the first time since 2009, according to a Bloomberg index.
“We are yet to see the bulk of the impact of rate rises on the economy,” said Pauline Chrystal, a portfolio manager at Kapstream Capital in Sydney. “We still expect to see a deterioration in activity, employment, and increase in defaults.”
Elsewhere in credit markets:
Asia
Deal flow in the Asian dollar bond market was muted on Monday with a week-long closure of Chinese markets for Golden Week and a holiday in South Korea.
Losses in Asian dollar bonds extended to a fifth consecutive quarter, the longest such stretch on record. The notes slumped 4.2% in the three months ended Sept. 30
Still, that is a smaller loss than the two previous quarters, following policy steps in China to help the nation’s troubled property sector
The latest sign of such stimulus came late last week, when people familiar with the matter said financial regulators told the biggest state-owned banks to provide financing worth at least $85 billion to the battered property sector
Chinese developer stocks and bonds rallied Monday after that news
Some dollar bonds of China Huarong are poised to extend gains Monday after the bad-debt manager announced last week plans to buy back certain offshore notes and redeem a perpetual note
Smaller brokerages are gaining business in Japan’s credit market after former top player SMBC Nikko Securities Inc. was affected by a trading scandal
Americas
US junk bonds are headed for the worst year-to-date losses on record.
In the investment-grade primary bond market, there were no new issuers on Friday, wrapping up an abysmal week that saw just $1.7 billion sold
The cruise sector is rebounding slower than expected with cruise line companies Carnival and Royal Caribbean seeing bond prices drop on Friday
Mortgage backed securities are presenting one of the most attractive entry points of the last 10 years given a combination of yield and low prepayment risk, an analyst wrote
EMEA
The region’s primary bond market missed expectations for issuance, at just over €15 billion ($14.7 billion), with Friday being the 39th day without sales this year.
Banks funding the acquisition of House of HR’s are likely to keep about a quarter of the deal on their balance sheets, adding to the billions of hung debt stuck on lenders’ books
In the UK, gilts have seen some respite after a recent selloff on optimism surrounding the government’s meeting with the Office of Budget Responsibility
Sustainable sales are setting records in Germany’s Schuldschein debt market, reaching more than €8 billion in the first three quarters of the year, topping previous full-year totals
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