Global Corporate Bond Market Looking Junkier

October 26, 2015 5:00 PM

For years, financial markets have been fretting about "looming" Federal Reserve interest rate hikes that keep getting pushed further into the future. One of investors' greatest fears is what could happen to corporate bonds, which experienced a boom linked to aggressive stimulus measures from world central banks, when the Fed began to tighten monetary policy for the first time in nearly a decade.

But something funny happened in recent months: Corporate bond markets retreated despite expectations that the Fed wouldn't be touching official borrowing costs, at zero since late 2008, at least until early 2016 (see Fortune and Bloomberg).

For years now, corporate bonds have been the darlings of Wall Street as investors sought higher returns amid low official interest rates from the Federal Reserve and the European Central Bank. The energy sector saw especially high levels of borrowing as America's fracking boom took off. Now that the prices of oil and other commodities have tanked, that sector is leading the way in losses.

The corporate bond bonanza extended beyond US shores, and many emerging markets also got in on the action while the going was good and liquidity remained ample. Now that some signs of strain are beginning to emerge, a common theme recurrent with the causes of the 2008 financial crisis begins to emerge across firms and countries—leverage hurts on the way down.

José Viñals, financial counselor and director of the Monetary and Capital Markets Department of the International Monetary Fund, flagged such risks in a presentation at the Peterson Institute for International Economics.

He flagged the possibility that, because of close ties between major developing-country corporations and their home governments, any crisis in corporate debt could quickly hit sovereign bonds as well.

Economist Yu Yongding, of Chinese Academy of Social Sciences, cited worries about corporate bonds in his own country during a presentation last month.

"The rise in China's corporate debt-to-GDP ratio imposes [a] most serious threat to China's financial stability in medium and long term," he said.

The market is already showing signs of strain for local bankers, Bloomberg reports.

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Pedro Nicolaci da Costa Former Research Staff

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