London: A meltdown in UK assets during Liz Truss’s first month as prime minister has left the sterling corporate bond market notching up its worst monthly return ever.
A Bloomberg index of sterling-denominated high-grade corporate bonds fell 9.6 per cent in September, the most since the index began. The measure comprises a majority of British companies, as well as others with sterling debt. It’s also the biggest monthly underperformance for pound-denominated debt compared to similar euro and US dollar credit since 2009, according to Bloomberg indexes.
The slump comes amid a meltdown for UK assets this week, with the pound touching a record low and a historic surge in borrowing costs spurred by concerns that Truss’s radical unfunded tax-cutting package will balloon the country’s debt and stoke inflation further. With the government’s fiscal policy at odds with the country’s central bank - and the Bank of England forced to intervene to stave off a bigger market crisis - investors are even more sour on the UK than they were before.
“If I could unwind all of my longs in sterling bonds, and it wasn’t too expensive to do that, I would probably be a seller and instead buy bonds in another currency,” said Andrea Seminara, chief executive at Redhedge Asset Management.
Soaring inflation
While US dollar, euro and sterling corporate bond indexes have all been falling this year as central banks try to combat soaring inflation through rate hikes, the more than 9 per cent loss in five to seven-year sterling corporate bonds in September was more than double the drop elsewhere.
“The upcoming BOE credit sales, expected rate hikes and the chaotic mini-budget have been key drivers of losses in sterling credit, which is underperforming European peers in euros and may continue to suffer on credit-unfriendly policies,” BI strategists Mahesh Bhimalingam and Heema Patel wrote in a note on Thursday.
The rise in yields - with a Bloomberg index showing high-grade sterling debt yielding an average of 6.8 per cent on Friday, up from 5.1 per cent at the end of August - has had a profound impact on the value of bonds, which fall as the yields rise. And that’s resulting in big mark-to-market losses for portfolio managers who piled into a pandemic-era issuance wave by companies seeking to lock in low funding costs.
Notes in the sterling benchmark high-grade index issued in 2020 with an average tenor of more than 12 years are now indicated at about 75 pence, based on data compiled by Bloomberg. The 2021 vintage is quoted at average bid prices of 73 pence. A price of less than 80 per cent below face value - or 80 pence for sterling debt - is generally considered to be distressed.
Liability-driven investment
Prices have also reached extreme levels in some longer-maturity corporate bonds, which have been affected by the forced selling by liability-driven investment strategies during the market turmoil. A 50-year bond issued 15 months ago by triple-A rated Wellcome Trust is now quoted at just 42 pence.
While these levels would often be a buying opportunity, investors are concerned that factors that could trigger a rebound are not in place yet.
“There is high uncertainty surrounding the BOE reaction function that will continue pressure on sterling credit,” said Elisa Belgacem, senior credit strategist at Generali Investments. “Even if the government backpedals on part of the mini-budget, it might not be enough to change sentiment.”
As buyers avoid sterling assets, cases of pound bond yields rising well above euro bonds of even the same issuer are becoming increasingly common. The yield on a sterling note by Volkswagen Financial Services AG maturing in April 2025 was offering as much as 1 per cent more than a similar euro note by the same borrower this week, even after accounting for the cost of hedging currency fluctuations.
“You have currency issues, technical issues and policy issues,” said Redhedge’s Seminara. “The premiums have to be much wider than comparable euro bonds.”
