What about the risk in the bond market?

30th October 2018
-IAM, News

Alberto Alvarez, Sernior Trading Officer

Ten years after the bankruptcy of Lehman Brothers, which occurred on September 15, 2008, many are wondering about the possibility of another major crisis.

While banks now have a more favourable financial situation than in the past, thanks in particular to the numerous measures taken to improve their balance sheets and strengthen their capitalisation, this is not the case for many companies. They have been heavily indebted in recent years and general level of indebtedness is worrying and could be a trigger for a new generalised crisis. The reason why the level of debt of companies found on the financial markets is currently at its highest, is because they benefit, among others, from an environment of extremely low and favourable interest rates – environment, which persists for some years already. Investors, on the other hand, have been less risk-averse in recent years and have not hesitated to invest more in lower-quality assets, looking for returns and aiming to gain a few additional base points. Thus, and with a gradual rise in interest rates, already noted in the United States, we are entitled to worry about the accumulation of debt of certain companies.

The following table shows the evolution over the last ten years of the “Bloomberg Barclays Global Aggregate Corporate Bond Index”, which covers corporate issues:

The increase in the volume of debt is impressive and much larger in the US than in Europe. Indeed, the debt is multiplied by almost 2.5 in the US and 1.5 times in Europe. At the same time the duration has increased in both regions. Debt quality has also fallen sharply, with the doubling of the proportion of low quality issuers (BBBs) in the index.

These statistics reflect a riskier environment, and in recent months credit spreads have been rising again after two years of bearish momentum. Is this the beginning of a trend reversal and a confirmed riskier environment? Let’s keep an eye on the evolution…