Key measures of credit risk surged globally on Monday due to mounting concerns about weakening economic growth. This turmoil effectively halted US company bond sales on what had been expected to be one of the busiest days of the year.

Credit Risk Gauges Spike

A gauge of perceived risk in US corporate credit markets spiked by up to 7.4 basis points to 65.657 basis points on Monday morning, marking the largest one-day increase since March 2023, following the collapse of Silicon Valley Bank (NASDAQ: SIVB). In Europe, credit default swap indexes also surged, reflecting heightened concerns about company defaults.

Impact on Bond Sales and Corporate Debt

Blue-chip companies scheduled to sell bonds in the US on Monday withdrew amid the turmoil, according to debt underwriters. This was only the second Monday this year without investment-grade bond sales, excluding holidays. With approximately 10 sales expected, it would have been one of the busiest sessions of 2024 by number of offerings.

Late last week, Wall Street syndicate desks anticipated about $40 billion in US investment-grade bond sales this week, with roughly half projected for Monday. The timing of these sales remains uncertain. In the leveraged loan market, SBA Communications Corp. (NYSE:SBAC) postponed the repricing of a $2.3 billion loan slated to conclude this week.

Economic Headwinds and Fed Rate Cuts

Corporate debt is facing multiple headwinds. The US jobs report from Friday suggested a faster-than-expected slowdown in hiring, raising recession concerns. Economic weakness could further strain companies’ ability to meet their financial obligations.

Additionally, the Federal Reserve is now expected to cut rates more aggressively than previously anticipated, which could make borrowing cheaper and stimulate more debt sales. However, as Treasury markets stabilize and corporations resume debt sales, the volume could be heavy, potentially weakening corporate debt prices relative to Treasuries.

Credit Market Outlook and Investor Sentiment

The result is a potential rise in corporate bond prices, joining a broader fixed-income rally as investors prepare for interest rate reductions. However, credit products are likely to lag behind Treasuries, with money managers demanding higher yields relative to government debt to compensate for default risk, pushing spreads wider.

Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, anticipates continued widening of spreads, citing potential substantial downside from current levels.

In the leveraged loan market, more than 15 deals are due this week, including several dividend deals and one acquisition. It remains unclear if additional deals will be delayed, as was the case with SBA Communications Corp.’s loan.

European and Asian Credit Markets

In Europe, an index tracking credit default swaps for junk-rated companies jumped by the most since March 2023, when Credit Suisse collapsed. In Asia, a credit derivatives gauge rose to its highest level since May, with yield premiums for high-grade dollar bonds in the region set for the largest surge in 22 months, according to traders and a Bloomberg index.

These moves follow a global stock market rout and a spike in the Wall Street stock market fear gauge, the CBOE Volatility Index (VIX), to its highest level since 2020. The concern is that the Fed has been slow to react to rate cuts, potentially pushing the world’s richest economy toward recession. The timing of these developments is critical given the typically low trading volumes in August.

Future Outlook and Market Adjustments

Investors will need to navigate not only the realities of an economic slowdown but also uncertainties arising from geopolitical risks, such as potential conflicts in the Middle East, according to Raphael Thuin, head of capital market strategies at Tikehau Capital.

Despite a year of declining perceived credit risk and investor focus on elevated yields, the latest gyrations suggest a potential turning point if concerns about a worse-than-expected slowdown deepen. The default rate for Bloomberg’s European junk index has climbed to 2.96%, surpassing the 1.8% rate seen during the COVID-19 pandemic.

Goldman Sachs Group Inc. (NYSE:GS) economists have increased the probability of a US recession in the next year to 25% from 15%, while also noting reasons for optimism despite rising unemployment. They expect the US central bank to reduce rates by 25 basis points in September, November, and December.

Bloomberg Intelligence Chief European Credit Strategist Mahesh Bhimalingam predicts that the current risk-off sentiment in credit markets will eventually subside, with solid credit metrics and upcoming central bank actions providing support.

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