The glass half full

A new year brings new resolutions, and a reset on financial performance. For bond investors, the two main aggregates — interest rates and spreads — are sending conflicting signals. So, what should they be looking at?

Get expert insights from Catherine Reichlin, Senior Bond Analyst, in our latest Bond Moment.

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Interest rates are at attractive levels in many economies, but spreads are at historically low levels. In other words, the difference between government and corporate bond yields is small.

There are two reasons for this difference: government yields are "too high" or companies are in excellent health.

As far as the former is concerned, we should remember that government debt has soared, as have budget deficits, not to mention growing political instability.

In Europe, we are even seeing a convergence between the countries on the periphery, which have carried out their reforms, and those at the heart of the region, such as France and Germany.

The same trend can be seen in corporate bonds: a Novartis bond maturing in 2028, denominated in euros, is currently yielding less than a French bond with the same maturity!

The low spread levels should therefore be seen in the context of the deterioration in government debt, which should make corporate bonds immune for some time to come.

The latter are benefiting from this trend, although there is still no real distinction between the quality of companies' balance sheets. Investors are buying bonds with much higher coupons than in recent years, and even if volatility rises, these higher yields provide a cushion.

Does this mean that the market has gone blind and is buying all new issues indiscriminately? Not really. Investors are still paying attention, even amid the frenzy at the start of the year.

Concession premiums, the extra yield offered on a new bond, have fallen from 8.5 basis points (bps) in 2023 to 3.5 bps in 2024 and to just 2.1 bps on 6 January 2025.

Demand has fallen as a result, with the bid/cover ratio falling from almost 4x to less than 3x at the start of this year.

Another indicator of the trend is the withdrawal of orders when terms are revised downwards (attrition).

While this was only 18% in 2023, it has risen to 24% at the start of this year. Brazil's JBS experienced this first-hand when it issued a 30-year bond with an initial announced spread of 195bp.

Following the success in the order books, the spread was tightened by ... 32.5 bps, resulting in ... a negative concession premium (-7.5 bps)!

Faced with this new price, many investors pulled out: 62% of the order books evaporated. The secondary market reacted reasonably well, but the bond failed to catch fire, confirming the increased selectivity of investors.

The new bonds issued on 7 January avoided the extremes seen at the beginning of the year and have already improved the market's receptiveness. A reassuring sign that there are opportunities to be seized, but not at any price.