Barclays warns of credit pain in return to 1970s inflation regime

Rising prices amid a slowing US economy will threaten troubled credit markets, if history repeats itself.

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(Bloomberg) – Rising prices amid a slowing US economy will threaten struggling credit markets, if history repeats itself.

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The current inflation and growth environment most closely resembles the periods from 1973 to 1975 and 1978 to 1980, when credit markets performed poorly, according to Barclays Plc. strategists led by Dominique Toublan.

“Credit performance was poor then, and we don’t expect this time to be any different,” the strategists wrote in a note dated Aug. 12. The asset class “could struggle even more if the current stagflationary backdrop turns into a deflationary one.”

During the periods of high inflation and low growth of the 1970s, monthly excess returns on investment grade credit averaged negative 14 basis points. Monthly performance was negative 58% of the time, about 15% above the long-term average, the strategists wrote.

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Credit markets have been battered this year, especially high-quality ones, as Treasury yields jumped and the Federal Reserve raised rates to fight inflation. Despite a rally in July — which marked the best monthly return in two years — investment-grade bonds are down nearly 12% for 2022 so far, according to Bloomberg index data.

According to Barclays, bonds issued by technology companies, banks and basic industry sectors have outperformed in inflationary years, in both investment grade and high yield. Higher quality energy debt and subprime insurance debt also held up better.

During periods of stagflation, insurance, communications and cyclical consumer sectors underperformed, the strategists wrote.

“Stagflationary environments have not been credit friendly, with returns averaging negative as the growth backdrop deteriorates,” the strategists wrote.

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Credit investors should beware of stagflation or significantly slower growth, according to Terence Wheat, co-head of investment grade corporate bonds at PGIM Fixed Income. He expects higher quality spreads to tighten from current levels before widening by the end of the year as the US economy slows.

The spread on the high-grade benchmark narrowed to 131 basis points on Monday, from the 2022 high of 160 basis points reached on July 5.

“There’s always a chance of a deeper recession happening, so we have to be wary of that,” Wheat said.

There is, however, evidence that the worst of inflation may be over, according to David Norris, head of US credit at TwentyFour Asset Management. “Inflation talk is what’s going to drive performance,” he said. “There are very good arguments to suggest that he has reached his peak.”

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Norris expects higher quality debt to perform better in the fourth quarter. He considers spreads of 150 basis points to 160 basis points as good entry points.

Elsewhere in the credit markets:

Americas

Ford Motor Co is taking advantage of a recovery in the credit market to sell green bonds. The automaker is issuing a 10-year unsecured green bond with preliminary pricing talks suggesting a yield of around 6.4%, according to a person familiar with the matter.

  • Emerging-market companies are refinancing foreign-currency bonds at the slowest pace in seven years as central banks in the United States and Europe hike interest rates, backing away from the easy-money policies on which corporations in the around the world once relied on to reduce their costs
  • Olympus Water US Holding, a chemical supplier and manufacturer, markets $325 million junk bond sale to help fund Clearon acquisition
    • Pricing is scheduled for August 17
  • Commitments are due on two leveraged loans, including a $300 million deal for The Chefs’ Warehouse that will refinance debt and add cash to the company’s balance sheet
  • For deals updates, click here for the New Issue Monitor
  • To learn more, click here for Credit Daybook Americas

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EMEA

Financial issuers plunged in the primary market on Tuesday, triggering the most selling in more than a month.

  • Issuance returned after a high-quality bond risk gauge remained below 100 for a fourth straight day and European stocks climbed
  • High-yield company Storskogen is suspending plans to issue its first euro bond due to volatile market conditions, CEO Daniel Kaplan says
  • The ECB added three new securities to its CSPP and PEPP programs in the week ended August 12, according to central bank data analyzed by Bloomberg
  • After the worst half of memory in European credit markets, a rebound in corporate debt sales in the second half is likely, according to Bloomberg Opinion columnist Marcus Ashworth

Asia

Chinese developer stocks and dollar bonds jumped on Tuesday following reports of a plan that could help some raise new funding that is ultimately guaranteed by the state.

  • Mobile operator DITO Telecommunity Corporation is seeking to extend the maturity of an $800 million debt from Bank of China Ltd. and eventually convert it into a long-term loan
  • Spreads on the Meituan Class B 2030 dollar bond widened sharply, following a Reuters report that Tencent Holdings Ltd. plans to sell all or part of its stake in the food delivery giant
  • South Korean retail investors are buying more bonds sold by non-bank financial companies due to higher yields and shorter durations, contributing to a tightening of their spreads, according to Kiwoom Securities

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