Credit Is So Hot That Traders Are Building Shorts

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(Bloomberg) — Asset managers with cash to spend and few new deals to buy have made debt spreads nearly as many times as the global economy remains strong. That’s a sign to some that it’s time to buy reverse protection.

Corporate bond shorts rose 25% to about $336 million last year compared with a 10.6% rise in institutional claims to $4.6 trillion, according to data compiled by S&P Global Market Intelligence. Rate wagers will now stand at the equivalent of 7.3% long-term, up from 6.4% last year, based on securities lending.

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The rise in shorts comes as the comfort ratio hits its highest level since 2021, the number of distressed loans falls to record lows this year and US economic growth continues to confound skeptics. But the expectation is that incoming President Donald Trump’s policies on taxes and immigration will increase economists’ inflation concerns, leading some fund managers to hedge their bets.

“Large inflows of high-yield bonds in the US and Europe are causing spreads to tighten. “If valuations are very tight, short-term bonds can be very profitable and hedge funds using quantitative strategies will use all these valuation metrics,” said Zachary Swabe, high yield portfolio manager at UBS Asset Management.

Any “deterioration in the big picture will give funds a good reason to short security,” he said.

There are reasons for concern. US monetary policy is “on an uncontrollable trajectory,” according to economists at Apollo Global Management, with S&P 500 earnings misses rising and funding costs in overnight repo markets rising at a corresponding rate. Adding to the difficulty, Germany’s economy has been sluggish and China has yet to see broad-based growth after a wave of stimulus.

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Despite the warning signs, the spread on US junk bonds now stands 30 basis points higher than everyone else’s, set before the global financial crisis. And while risk premiums in Europe will still have to continue until the end, they have fallen well below their historical average.

Hedging Strategy

Investors may also reduce corporate debt as part of a broader consolidation strategy to reduce long positions in stocks or other assets that may be sensitive to credit conditions, according to S&P Global Market Intelligence director Matthew Chessum.

Market makers at banks are also borrowing bonds to sell to asset managers trying to inject new money into the business, leaving sellers short until they can buy the debt, according to two people with knowledge of the matter.

If they didn’t, banks wouldn’t have been able to handle the huge refinancing orders in recent months as banks’ inventory has shrunk due to post-crisis regulations, the people said, asking not to be identified because they are not authorized. to speak openly.

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However, doubts about the state of the market can also be seen beyond the short data. Indicators of default swaps covering a basket of junk-rated companies in Europe and North America have not tightened as much as the bond spreads they insure against.

Reducing securities will pay off if the economic picture suddenly darkens. Morgan Stanley strategists warned last week that corporate credit performance will slow in the second half of next year as “animal spirits” grow and “take hold.”

Review Week

• Companies are rushing to sell bonds and loans before markets slow down during the Thanksgiving and December holidays. High-quality US corporate bond sales rose to the second-highest level on record.
• About $185 billion in U.S. mortgages were issued this year, setting a record annual issuance for the third time since 2018.
• A unit of the Adani Group has called off a $600 million green bond sale after US prosecutors charged founder Gautam Adani with involvement in a bribery scheme. Adani’s bonds and shares fell. Adani Group said the allegations are baseless, and they will seek all legal means to defend themselves.
• Some of Wall Street’s biggest banks are partnering with BlackRock Inc.’s Aladdin technology system. to provide real-time data on US corporate bond trading prices.
• Barings LLC is pricing the first European sovereign debt obligation backed by a pool of sovereign debt.
• Spirit Airlines Inc. filed for bankruptcy in a bid to give control to bondholders after failing to agree a merger with rivals.
• RR Donnelley and Sons Co. they returned to the junk-bond market with a deal that could pay up to a 12% coupon thanks to a rare feature that allows the company to choose how it pays interest.
• Blackstone Inc. is considering tapping the secured 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 merger with Investec Bank Plc, to expand its offering in the fund market.
• The AI ​​frenzy that helped AppLovin Corp., a company shunned by Silicon Valley a decade ago, took in a $3.5 billion blue-chip sale that was eight times what it needed.
• Citigroup Inc and Banco Santander SA are studying a debt package of up to €4 billion ($4.2 billion) to finance the possible sale of Spanish waste management company Urbaser SA.
• US banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. are asking investors to disclose whether they plan to use additional debt to invest in key risk transfers as regulators consider them a threat to financial stability.
• EQT AB’s Dechra Pharmaceuticals Ltd. wants to retire its private equity mortgage loan.
• Apollo Global Management is raising an estimated £500 million ($631 million) private equity loan to finance Cinven’s acquisition of Grant Thornton’s UK business.
• Medical Properties Trust Inc. has moved to take control of three Southern California health care organizations after accusing the owner – Prospect Medical Holdings – of defaulting on debt.
• Healthcare company FinThrive’s debt refinancing announced this week includes below-average trades and favorable terms for creditors.

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On a trip

• Bank of Nova Scotia hired Brian Lehman from Generate Capital as the second of two heads of operations for its US markets. The bank said last month that Nicole Frew, a former chief compliance officer for lenders, will become its new head of the Americas.
• John Cho has been named private equity leader at KPMG Canada LLP, a new role the firm has created to expand its presence in the fast-growing space. Cho was also named chief adviser on inter-American treaties.
• The Alberta government has appointed former Canadian Prime Minister Stephen Harper to lead the board of the pension fund manager, less than two weeks after firing the chief executive and all directors.

—Courtesy of Abhinav Ramnarayan and Dan Wilchins.

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