With jumbo corporate bond issuances from AT&T, Tesla and Amazon hot off the press, it would be easy to draw the conclusion that “credit markets are rock solid,” said the Axa CIO of fixed income.
Supportive macro and credit fundamentals are further fuelling this narrative of strength, potentially luring investors into a false sense of complacency.
However, it would only take a “change in sentiment” brought on by a political or economic shock to impact equity valuations and credit fundamentals.
“A deterioration in sentiment will lead to selling,” he said.
“It is this technical picture that is perhaps the most worrying and misunderstood part of the puzzle.”
Perhaps the Amazon deal went so well because investors, including ETFs, needed to buy it to maintain index weightings, Iggo speculated.
But “can markets cope with a negative liquidity event should those flows that have gone into credit markets through ETFs reverse?” he asked.
Or “is part of the technical nature of the bond market related to monetary policy and the fact that interest rates are zero and investors have been crowded into bonds?”
Although there may not be any immediate reason to expect credit risk premium to rise significantly, according to Iggo, active investors shouldn’t expect markets to remain benign forever.
He said: “One tranche of the Amazon deal was a 40-year bond that was issued with a 14 basis point spread above US Treasuries. Held to maturity that would provide a compound 77% better return than owning the equivalent US government bond.
“Clearly many investors find this attractive and are happy to be a creditor to an online retailing giant that is increasing market share of consumer spending.
“For more active portfolios, however, there is a clear risk that the market will not stay so benign and marked to market losses will be experienced. Believing the market expensive requires managers to be hyper sensitive to any evidence that the fundamentals are changing.”
