Recession fears leave 40 billion euros of European corporate bonds in distress

More than 40 billion euros of European corporate bonds are now trading at difficult levels, showing how the deteriorating economic outlook has sparked growing concern about companies’ ability to service debt.

The pile of euro-denominated corporate bonds showing warning signs jumped by 6 billion euros at the end of 2021, according to Financial Times calculations based on Ice Data Services indices.

The stock of distressed corporate debt more than doubled between May 31 and June 30 alone, underscoring how quickly concerns are mounting that central bank decisions to tighten monetary policy could tip major economies in recession. Investors also worry that high levels of inflation will increase the costs of running businesses.

“Credit markets have shifted rapidly toward pricing during a recession,” European credit analysts at JPMorgan said Friday.

The investment bank’s cautious sentiment follows a report earlier this week from S&P Global, which warned of an “increasingly murky outlook for credit quality” in Europe.

“Credit ratings are expected to come under pressure in 2023 as supply constraints keep food and energy prices high, households increasingly grapple with falling real incomes and central banks are prioritizing inflation over growth,” the rating agency said.

The austere sentiment marks a sharp shift from the rush into risky assets that was sparked by the huge stimulus measures central banks and governments rolled out to counter the 2020 coronavirus crisis.

Bonds trading at distressed levels – outperforming government benchmarks, or spread, by more than 10 percentage points – now account for 8.8% of the Ice index of euro-denominated junk bonds , down from 1.3% at the end of 2021 .

This shows that investors are pricing in the possibility that they won’t receive cash when the bonds mature, pushing up corporate bond yields.

Meanwhile, the iTraxx Crossover, which tracks the cost of junk bond credit default swaps – insurance-like products that protect against defaults on Europe’s riskiest bonds – hit levels seen for the last time in April 2020.

Line chart of the iTraxx Crossover Index (spread, basis points) showing the cost of European corporate junk bond default protection rising

The lack of demand for riskier bonds suggests that less creditworthy European companies may find it difficult to refinance their debt and will have to guarantee higher yields to investors to attract financing. Underscoring those concerns, JPMorgan analysts noted on Friday that there had been “an alarming freeze in lending conditions in the capital market, which has gradually extended the quality curve.”

Demand is also down for US high yield debt. Marty Fridson, chief investment officer at Lehmann Livian Fridson, whose calculations show the distress rate for US high-yield debt at 7.8%, said the rise was a sign of an intensification of the economic nervousness.

He said: “This rise is not unusual [for periods of economic uncertainty] but this type of rise has often, if not always, been associated with an impending recession.

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