Fear of recession leaves €40 billion in European corporate bonds in distress

More than €40 billion in European corporate bonds are now trading at distressed levels, highlighting how the deteriorating economic outlook has fueled growing concerns about companies’ ability to pay their debts.

According to Financial Times calculations based on Ice Data Services indices, the stack of euro-denominated corporate bonds with warning signs has risen from €6 billion at the end of 2021.

From May 31 to June 30 alone, the stock of corporate distressed debt more than doubled, underscoring the growing concern that central bank decisions to tighten monetary policy could send major economies into recession. Investors also worry that high inflation will increase operating costs for companies.

“Credit markets have moved rapidly toward recessionary pricing,” European credit analysts at JPMorgan said Friday.

Nominal debt column chart with spreads over 10 percentage points (€bn) showing stock of distressed European corporate bonds rising rapidly

The investment bank’s cautious sentiment followed a report earlier this week from S&P Global, which warned of the “increasingly murky outlook for credit quality” in Europe.

Credit ratings are likely to come under pressure in 2023 as supply constraints keep food and energy prices high, households increasingly grapple with falling real incomes and central banks prioritize inflation over growth.

The austere sentiment marks an abrupt shift in the rush into risky assets triggered by the massive stimulus measures put in place by central banks and governments to deal with the 2020 coronavirus crisis.

Bonds trading at distressed levels — with yields above government benchmarks, or spread, of more than 10 percentage points — now account for 8.8 percent of the Ice Index of euro-denominated junk bonds, compared to 1.3 percent at the end of the year. 2021 .

This shows that investors estimate the probability that they will not receive money when bonds mature, increasing corporate bond yields.

Meanwhile, the iTraxx Crossover, which tracks the cost of credit default swaps on junk bonds — insurance-like products that protect against defaults on Europe’s riskiest bonds — has risen to levels last seen in April 2020.

Line chart of the iTraxx Crossover Index (spread, basis points) showing the increase in European corporate bond default protection costs

The lack of demand for riskier bonds suggests that Europe’s least creditworthy companies could struggle to refinance debt and will need to guarantee investors higher returns to attract funding. Emphasizing those concerns, JPMorgan analysts noted on Friday that there had been an “alarming freeze in credit conditions in the capital market, which has gradually spread up the quality curve.”

Demand for high-yield US debt is also declining. Marty Fridson, chief investment officer at Lehmann Livian Fridson, whose calculations show the emergency ratio for US high-yield debt is 7.8 percent, said the rise is a sign of mounting economic turmoil.

He said: “This increase is not unusual [for periods of economic uncertainty] but that kind of rise has often, if not always, been associated with an impending recession.”

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