WHY CREDIT SPREADS CONTINUE TO TIGHTEN?

Yesterday (May, 4th) an unexpected up-grade by Fitch on Groupama’s rating ( from BBB+ to A- ) gave occasion to Groupama 6% 2027 sub. bond to climb   to 115.50 ( it was pricing in 107,90-108 range on May, 2nd) . Tried to sell 700k of these bonds  at 115.60 and found a buyer in 1 minute. (!)

Corporate bond markets are now very liquid , the risk appetite is very high ( too much high to me ) . I remember times ( January 2016 for example ) when I was trying to sell 100k of Sub. Bonds issued by European banks and couldn’t find a buyer the whole day  .

Starting from Trump’s election on November 9th , 2016  I believe  credit spreads continued to grind tighter amid fiscal policy optimism, record highs in equity markets, solid economic data,   and moderate new issue supply outside of refinancing activity. Strong earnings  help to achieve better Net Debt / Ebitda Ratio, but not in the very short term , because enterprises need something like 6 or 12 months to get better leverage after better profits .  And sometimes this is not even   true ,   if management decided to elevate the dividend    , or pay-out ratio,  in favour of  stakeholders  .

So the question is : Have   spreads   tightened too much in a too short time?

I’m afraid the answer is YES.

Corporate balance sheets are still relatively strong with stable credit metrics given limited M&A activity and shareholder activities in Europe and in USA, but there’s no doubt Central Banks support has been one of the main drivers for recent levels.

Banks continue to strengthen their capital base and have been reporting, on average, strong results relative to expectations. But solving NPL issues  in Eurozone  will take a long time.

High yield remains attractive relative to fixed income alternatives, and my expectations are that  investor demand will remain firm in the medium  term , while fund flows could increase.

However,in the short term,  valuations leave little room for price appreciation because many high-yield bonds are trading with yields  near their historical lows… Today Sub.Bonds and Hybrid Bonds , when they are callable at a very short date,  are yielding as if they were free-risk assets . In credit markets now, we are living  the same " irrational exuberance " as in equity markets… I don’t know what will be the catalyst for  the  next sell-off . But, when sell-off will come , it will be a kind of blood bath , I think…   (with a lot of buy opportunities as well .. .)