Investing Psychology




Corporate Debt Market under Pressure

Corporate Debt Market under Pressure

Aditya K

Corporate Debt Market under Pressure

The sharp downturn in global financial markets since mid-February 2020 has seen major indices such as the S&P500 drop greater than 30% since recent highs. Interestingly, whilst the focus around the world is on global equity markets, it is crucial to understand how the bond markets are weathering. The 10-year U.S. Treasury bond yields, which is used as a proxy for many other rates such as mortgage rates and auto loans, reached lows of 0.32% signalling an increased appetite for risk-free assets. This has translated to the U.S. corporate debt markets whereby the Federal Reserve has stepped in to keep the credit markets liquid by expanding its purchases of corporate bonds.

Corporate debt levels in the U.S reached US$9.6 trillion with the overall quality of bonds falling substantially in comparison to levels before the GFC in terms of higher payback requirements, longer maturities and subdued investor protection. This high level of corporate debt has made the U.S, particularly vulnerable to sharp downturns in global economic activity. As the quality of bonds have deteriorated over time there is a strong possibility of potential defaults. The graph below shows a significant rise in BBB rated investment grade bonds which is the lowest investment grade rating available and one level above ‘junk’. Just over half the composition of investment grade debt is BBB rated, which is up from 30% during the GFC. As a result, downturns in financial markets can lead to default rates increasing as rating agencies indicated that they are willing to downgrade bonds of unstable borrowers.


That being said, investors of high-quality corporate bonds rejoiced the Fed’s decision of buying $200 billion of corporate bonds. To provide liquidity for outstanding corporate bonds, the Fed has launched two credit facilities, a Primary Market Corporate Credit Facility to purchase corporate bonds directly from companies and make loans available to them, and a Secondary Market Corporate Credit Facility where they can buy corporate bonds in the secondary market. This stimulus from the Fed aims to push the down the borrowing costs in U.S. as an increase in demand for the corporate bonds raises their prices and hence reduces their yield. Treasury Secretary Steven Mnuchin announced that this program aims to help companies navigate through the coronavirus pandemic and that the Fed would mobilise “up to $4 trillion of liquidity”.

Locally, the Australian corporate debt levels stand at greater than $1 trillion, which is around 70% of the size of the listed share market. Australian corporate bond funds face a liquidity issue for government and corporate securities and in turn have increased their exit fees to meet redemptions funded by securities that are sole at vastly discounted prices. As a result, exit fees that were originally at a range of 10-55 basis points have now increased to highs of 200 basis points. The RBA has purchased approximately $13 billion in bonds to counter the severely distressed corporate debt markets. Governor Lowe reiterated RBA’s strategy of yield curve control are confirmed that they “are prepared to transact in whatever quantities are necessary to achieve this objective”.

With the corporate debt market currently facing a liquidity crisis and potential downgrades from credit issuers, the only thing in the way of a corporate debt market meltdown is the ongoing intervention of central banks.

Ready to invest with Maqro today?

Sign up to Maqro