BoE: “…close to zero compensation for risk in sterling corporate bonds”
27th June 2018
We flagged back in November that corporate bond risk premia were the lowest ever. Our analysis applied to the US corporate bond market, given that public daily data exist estimating US term premia. Since we wrote the blog, risk premia have increased a little, but remain exceptionally low on an historical basis.
Interestingly, the Bank of England has come to the same conclusion regarding the UK, as per its Financial Stability Report released this morning…
“…in recent months there has been some reduction in risk appetite in advanced economy and domestic debt markets. For example, sterling investment‑grade corporate bond spreads have increased by around 30 basis points since their recent low in early 2018, and have returned to the levels last seen over a year ago. However, the adjusted compensation investors have been demanding for interest rate and credit risk has not increased to the same extent. The FPC continues to scrutinise this area of risk. Sustained growth of corporate credit — even if facilitated by borrowing through capital markets — could affect the resilience of the core banking system. It could do so directly, if banks become unable to distribute some of the leveraged loans in their underwriting pipeline which they originally intended to pass to investors. In addition, it could have an indirect effect on bank resilience, if highly leveraged companies amplify economic downturns by seeking to reduce their debt and thereby raising the risks banks face on all exposures.”
It remains one of our highest conviction views that credit in general offers (to quote the Bank of England) close to zero compensation for risk, at a time when investors should be demanding higher compensation, whether it is due to the increased risk of a global economic slowdown (eg shape of US yield curve), fall in real global money supply growth or the record amount of leverage in the (US) nonfinancial sector.