Investors are growing nervous of a sharp fall in the prices of risky corporate bonds as credit conditions for US businesses and households grow increasingly tighter.
The US Federal Reserve’s quarterly Senior Loan Officer Opinion Survey this week showed that 46 per cent of US banks plan to raise their lending standards due to worries about loan losses and deposit flight.
In the past, tighter lending standards have led to the spread, or gap, between yields for riskier corporate bonds and ultra-safe government bonds widening, because credit becomes riskier to own.
But while lending has not evaporated as feared following the collapse of Silicon Valley Bank in March, the spread between higher-yield bonds and Treasuries has stayed relatively tight, leaving investors speculating that a correction is coming.
“In terms of why corporate bond spreads have not yet moved, I think it is simply because lending standards are a lead indicator on the real economy,” said Mike Riddell, a bond fund manager at Allianz Global Investors.
“We think that global risk premia will move sharply higher once the exceptionally tight lending standards begin to have a major impact on global growth, which is due to happen imminently.”
Ultimately, he said, it takes at least a year for a change in interest rates to have the full impact on the economy. The Fed started raising rates in March last year.
Investors’ worries over the health of the US banking system are still rippling through markets, more than two months since the failure of SVB. PacWest shares have lost more than a fifth in value this week after the bank announced it lost almost a tenth of its deposits in the first week of May. The KBW regional banks index, which tracks midsized and local US banks, has shed 35 per cent since the start of the year.
“The failures of several banks in recent months have been relatively well contained, and a 2008-style crisis looks much less likely than it did when Silicon Valley Bank collapsed in March,” said Eugene Philalithis, head of multi-asset investments at Fidelity. “However, the US banking sector remains in a slow-motion crunch.”
Fidelity believes high-yield US bonds look particularly vulnerable to tighter lending. Spreads are at levels consistent with a “more benign outlook than reality suggests”, according to Philalithis, who is buying highly rated sovereign bonds and avoiding risky credit.
Howard Cunningham, fixed income portfolio manager at Newton Investment Management, has said he has also “sharply reduced” exposure to high-yield bonds because “where lending standards go junk bond yields will follow”.
In its financial stability report earlier this week, the Fed cited the chance of a credit crunch among the biggest current risks to the financial system but not the Fed’s most likely scenario.