(Bloomberg) — Asset managers with money to spend and few new deals to buy have pushed credit spreads to near all-time tights as the global economy remains strong. That’s a signal for some that it’s time to buy downside protection.
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Corporate bond shorts have risen 25% to almost $336 billion in the past year compared with a rise of 10.6% in institutional longs to $4.6 trillion, according to data compiled by S&P Global Market Intelligence. Wagers that prices will fall now stand at the equivalent of 7.3% of longs, up from 6.4% a year ago, based on securities borrowing.
The rise in shorts comes as a gauge of complacency reaches the highest level since 2021, the amount of distressed debt falls to the lowest this year and US economic growth continues to confound skeptics. But expectations that incoming President Donald Trump’s policies on tariffs and immigration will boost inflation worry economists, leading some fund overseers to hedge their bets.
“Large inflows into high-yield bond funds in the US and Europe are causing spreads to grind tighter. If valuations are screening extremely tight, shorting bonds can be highly profitable and hedge funds running quantitative strategies will use all these valuation metrics,” said Zachary Swabe, a high-yield portfolio manager at UBS Asset Management.
Any “deterioration in the macro outlook will also give funds a fair reason to short securities,” he said.
There are reasons for concern. US fiscal policy is on an “unsustainable path,” according to economists at Apollo Global Management, S&P 500 earnings misses are on the increase and funding costs in overnight repo markets are rising at a concerning rate. Adding to the woes, Germany’s economy has been moribund and China has yet to see a broader pickup in growth after a wave of stimulus.
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Despite the warning signs, spreads in US junk bonds now stand about 30 basis points above their all-time lows, set before the global financial crisis. And while risk premiums in Europe have further to go until they reach rock bottom, they have fallen well below their historical average.
Hedging Strategy
Investors may also be shorting corporate credit as part of a broader hedging strategy to offset long positions in equities or other assets that may be sensitive to debt conditions, according to S&P Global Market Intelligence director Matthew Chessum.
Market makers at banks are also borrowing bonds to sell to asset managers who are trying to put new money to work, leaving dealers effectively short until they can actually buy the debt, according to two people with knowledge of the matter.
If they didn’t do so, banks would have been unable to tackle large buy orders by funds in recent months as bank inventories have shrunk due to post-crisis regulations, the people said, asking not to be identified as they aren’t authorized to speak publicly.
Still, hesitancy about the state of the market can also be seen beyond the short data. Credit-default swap indexes covering a basket of junk-rated companies in Europe and North America have not tightened as much as the spreads of bonds they insure against.
Shorting the securities will pay off if the economic picture suddenly darkens. Credit strategists at JPMorgan Chase & Co. told clients recently that “we are potentially on the precipice of a global trade war with spreads already at tight levels.”
Morgan Stanley strategists, meanwhile, warned this past week that the performance of corporate credit is set to weaken in the second half of next year as “animal spirits” grow and “take hold.”
Week in Review
Companies are rushing to sell bonds and loans before markets slow down around Thanksgiving and the December holidays. US high-grade corporate bond sales climbed to the second-highest level on record.
Nearly $185 billion of US collateralized loan obligations have been issued this year, setting an annual issuance record for the third time since 2018.
A unit of Adani Group scrapped a $600 million green bond sale after US prosecutors charged founder Gautam Adani with participating in an alleged bribe plot. Adani’s bonds and shares dropped. Adani Group said the allegations are baseless, and that it would seek all possible legal recourse to defend itself.
Some of Wall Street’s biggest banks are teaming up with BlackRock Inc.’s Aladdin technology system to provide real-time pricing data for trading US corporate bonds.
Barings LLC priced Europe’s first collateralized loan obligation backed by a pool of private credit debt.
Spirit Airlines Inc. filed for bankruptcy with a plan to hand over control to bondholders after failing to agree on a merger with rivals.
R.R. Donnelley and Sons Co. is back in the junk-bond market with a deal that could pay up to a 12% coupon thanks to a rare feature that allows the firm to choose how it pays interest.
Blackstone Inc. is considering tapping the securitized debt market to help finance its acquisition of a majority stake in Jersey Mike’s.
Ares Management Corp. is exploring partnerships with other financial institutions, following its recent tie-up with Investec Bank Plc, to expand its offering in the fund finance market.
The anything AI frenzy helped AppLovin Corp., a company shunned by Silicon Valley’s money a decade ago, take on a $3.5 billion blue-chip sale that saw demand eight times that much.
Citigroup Inc and Banco Santander SA are readying an up to €4 billion ($4.2 billion) debt package to back a potential sale of Spanish waste-management company Urbaser SA.
US banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. are asking investors to disclose whether they plan to use additional debt to invest in significant risk transfers as regulators scrutinize them for threats to financial stability.
EQT AB’s Dechra Pharmaceuticals Ltd. is seeking to ditch its private credit debt for new broadly syndicated loans.
Apollo Global Management is leading a roughly £500 million ($631 million) private credit loan to back Cinven’s purchase of Grant Thornton’s UK business.
Medical Properties Trust Inc. has moved to take control of three Southern California health care entities after accusing the owner — Prospect Medical Holdings — of defaulting on debt.
Healthcare software company FinThrive’s debt refinancing announced this week includes below-par exchanges and sweeter terms for creditors who crafted the deal.
On the Move
Bank of Nova Scotia hired Brian Lehman from Generate Capital as the second of two co-heads of its US capital-markets operations. The bank said last month that Nicole Frew, previously the lender’s chief compliance officer, would be the other US co-head.
John Cho has been appointed the leader of private capital at KPMG Canada LLP, a new role the company has created to expand its presence in the fast-growing area. Cho was also named head of deal advisory for the Americas.
Alberta’s government named former Canadian Prime Minister Stephen Harper to lead the board of its public pension fund manager, less than two weeks after firing its chief executive officer and every director.
–With assistance from Abhinav Ramnarayan and Dan Wilchins.
(Updates with comment from JPMorgan strategists in penultimate paragraph. An earlier version of this story corrected the value of the shorts.)
