(Bloomberg) — Asset managers with money to spend and few new deals to buy have pushed credit spreads to nearly unprecedented tight levels as the global economy remains strong. That’s a signal to some that it’s time to buy downside protection.
Most read from Bloomberg
Short positions in corporate bonds rose 25% over the past year to nearly $336 billion, compared with a 10.6% increase in long institutional positions to $4.6 trillion, according to data compiled by S&P Global Market Intelligence. Bets that prices will fall now stand at the equivalent of 7.3% of long positions, compared to 6.4% a year ago, on a security borrowing basis.
The surge in short positions comes as complacency is at its highest level since 2021, the amount of distressed debt has fallen to its lowest level this year and US economic growth continues to confound skeptics. But expectations that incoming President Donald Trump’s policies on tariffs and immigration will fuel inflation are worrying economists, causing some fund regulators to hedge their bets.
“The large inflow into high-yield bond funds in the US and Europe is causing spreads to narrow. When valuations are extremely tight, shorting bonds can be very profitable and hedge funds using quantitative strategies will already be using these valuation metrics,” said Zachary Swabe, a high-yield portfolio manager at UBS Asset Management.
Any “deterioration in the macroeconomic outlook will also give funds a fair reason to short securities,” he said.
There are reasons for concern. US fiscal policy is on an “unsustainable path”, according to economists at Apollo Global Management, with profit losses in the S&P 500 increasing and borrowing costs in overnight repo markets rising at a worrying pace. Adding to the misery, Germany’s economy is moribund and China has yet to see a broader recovery in growth after a wave of stimulus.
Click here for a podcast on rescue financing with Oaktree Capital Management
Despite the warning signs, U.S. junk bond spreads are now about 30 basis points above their all-time lows from before the global financial crisis. And while risk premia in Europe still have further to go until they bottom out, they have fallen well below their historical average.
Hedging strategy
Investors can also short corporate credits as part of a broader hedging strategy to offset long positions in stocks or other assets that may be sensitive to debt conditions, according to Matthew Chessum, director of S&P Global Market Intelligence.
Market makers at banks are also borrowing bonds to sell to asset managers trying to put new money to work, effectively leaving dealers short until they can actually buy the debt, according to two people with knowledge of the matter.
Had they not done so, banks would not have been able to handle large buy orders through funds in recent months as bank inventories have shrunk due to post-crisis regulations, said the people, who asked not to be identified because they are not authorized. to speak publicly.
Yet there is also hesitation about the state of the market beyond the short figures. Credit-default swap indexes covering a basket of junk-rated companies in Europe and North America have not tightened as much as the spreads of bonds they insure against.
Shorting the securities will pay off if the economic picture suddenly darkens. Credit strategists from JPMorgan Chase & Co. recently told clients that “we may be on the brink of a global trade war, with spreads already tight.”
Morgan Stanley strategists, meanwhile, warned last week that corporate credit performance will weaken in the second half of next year as “animal spirits” grow and “take power.”
Weekly overview
Companies are rushing to sell bonds and loans before markets slow around Thanksgiving and the December holidays. Sales of US high-quality corporate bonds rose to their second-highest level ever.
Nearly $185 billion in U.S.-backed loan obligations have been issued this year, setting an annual issuance record for the third time since 2018.
A unit of the Adani Group has scrapped sales of $600 million worth of green bonds after US prosecutors charged founder Gautam Adani with taking part in an alleged bribery plot. Adani’s bonds and shares fell. Adani Group said the allegations are baseless and that it would take all possible legal action to defend itself.
Some of Wall Street’s largest banks have partnered with BlackRock Inc.’s Aladdin technology system. to provide real-time pricing data for US corporate bond trading.
Barings LLC has priced Europe’s first collateralized loan obligation backed by a pool of private credit debt.
Spirit Airlines Inc. has filed for bankruptcy with a plan to hand control to bondholders after failing to agree a merger with rivals.
RR Donnelley and Sons Co. is back in the junk bond market with a deal that could yield a coupon of up to 12% thanks to a rare feature that lets the company choose how it pays interest.
Blackstone Inc. is considering tapping the securitized debt market to help finance its acquisition of a majority stake in Jersey Mike’s.
Ares Management Corp. is exploring partnerships with other financial institutions, following its recent partnership with Investec Bank Plc, to expand its offering in the fund financing market.
The all-AI frenzy helped AppLovin Corp., a company shunned by Silicon Valley money a decade ago, land a $3.5 billion blue chip sale where demand was eight times greater.
Citigroup Inc and Banco Santander SA are preparing a debt package of up to €4 billion ($4.2 billion) to support a potential sale of Spanish waste management company Urbaser SA.
U.S. banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. are asking investors to reveal whether they plan to use additional debt to invest in significant risk transfers as regulators scrutinize them on threats to financial stability.
Dechra Pharmaceuticals Ltd. of EQT AB is trying to cancel its private credit debts for new, broadly syndicated loans.
Apollo Global Management is leading a private equity loan of approximately £500 million ($631 million) to support Cinven’s purchase of Grant Thornton’s UK operations.
Medical Properties Trust Inc. has taken steps to take control of three Southern California healthcare facilities after accusing its owner – Prospect Medical Holdings – of defaulting on debt.
Software company FinThrive’s debt refinancing announced this week includes substandard exchanges and better terms for creditors who made the deal.
Bank of Nova Scotia has hired Brian Lehman from Generate Capital as the second of two co-heads of its U.S. capital markets business. The bank said last month that Nicole Frew, previously the lender’s chief compliance officer, would be its other U.S. co-head.
John Cho has been named leader of private capital at KPMG Canada LLP, a new role the firm created to expand its presence in the fast-growing area. Cho was also named head of deal advisory for the Americas.
The Alberta government has appointed former Canadian Prime Minister Stephen Harper to head the board of the public pension fund manager, less than two weeks after firing its CEO and all directors.
–With help from Abhinav Ramnarayan and Dan Wilchins.
(Updates with comments from JPMorgan strategists in penultimate paragraph. An earlier version of this story corrected the value of the shorts.)
