Corporate Debt Rattles (Some) Economists’ Nerves

U.S. federal debt has reached $22 trillion for the first time in the nation’s history, reports revealed on Wednesday (Feb. 13), raising new concerns over government spending and the economy’s ability to make up for tax cuts.

But there’s another debt wave rising to new heights – and it, too, has sounded alarms over its potential to impact, and be impacted by, economic growth.

The current size of the BBB-grade (near junk) corporate bond market is now at the highest level it’s ever been. According to Gavekal Research Founding Partner and Chief Executive Officer Louis-Vincent Gave, this fact marks the largest source of potential economic instability. The total value of BBB-gate corporate debt is five times what it was just one decade ago, separate reports in MoneyWeek said, with half of $6 trillion in investment-grade corporate bonds now with a BBB rating.

“Part of the massive growth we’ve seen in the U.S. corporate bond market has really taken place in the BBB space,” Gave told Financial Sense reporters. “And so, if you start seeing an economic downturn (and the usual type of downgrades that occur in a downturn), then all of a sudden you have investment grade that becomes non-investment grade.”

Other analysts disagree, according to Bloomberg reports on Wednesday. Academy Securities Head of Macro Strategy Peter Tchir told the publication that an economic downturn may actually see BBB-grade bonds perform better than BB-rated ones. Voya Investment Management Senior High-Yield Portfolio Manager Randall Parrish agrees, telling Bloomberg that issuers of BBB-grade bonds are incentivized to maintain that investment grade rating, making widespread downgrades from BBB to junk an unlikely occurrence.

“The reach for yield in the BB space is not worth the increased risk, despite the potential long-term challenges associated with the BBB space,” added Adam Richmond at Morgan Stanley in a note published earlier this month, reports said.

The corporate bond market on the whole has been growing rapidly, with bond sales reaching $1 trillion at its fastest pace ever in 2017. Analysts noted that corporate treasurers had been taking advantage of lower rates.

The Federal Reserve’s recent signal that it will hold off on raising interest rates for now led to a spike in the U.S. corporate bond market, Bloomberg said earlier this month, with JPMorgan Chase and Bank of America strategists pointing to a lower risk of recession. The riskiest bonds, those with a CCC grade, saw the highest gains so far this year, reports noted.

But Gavekal’s Gave warned that the rapid acceleration of the corporate bond market could introduce instability, particularly in certain industries.

“There are real questions about all the energy debt that’s being issued by a lot of negative cash flow companies in the energy space,” he said, according to reports in Seeking Alpha, adding that there are similar questions arising in the auto, real estate and industrial spaces as well.

Total non-financial corporate debt in the U.S. is now 46 percent of overall GDP, with some analysts comparing today’s corporate debt-to-GDP ratio to that of the mortgage debt-to-GDP ratio seen before the housing bubble burst, reports in MoneyWeek said.

U.S. companies are also pointing to China as a threat to the global financial markets and economy, Gave added – a market that is in the midst of its own corporate bond struggles.

Financial Times reported in January that reduced appetite for risk and maturing issuance could continue the wave of corporate bond defaults that hit China last year, topping $22.3 billion. While monetary policy has aimed to support smaller businesses and public companies, analysts at the time said they have yet to impact the private sector, which has been hit hardest by the bond defaults.

“Although the government is also pledging more corporate tax cuts, their scale is unlikely to be enough to offset growing investor concerns about the credit risks surrounding corporate bonds,” FT said at the time.

Reuters reported this week that China’s National Development and Reform Commission (NDRC) is now launching an investigation into the nation’s corporate bond risks, with new requirements that local authorities will be required to check on companies and their ability to repay bonds.