Borrowing costs for investment-grade companies in the eurozone have fallen below their counterparts in Japan to the lowest in the world as the damaging economic impact of a second spike in COVID-19 cases on the continent is expected to be countered by increased monetary stimulus by the European Central Bank.
The spread of the COVID-19 pandemic in March caused markets to demand higher returns to take on risk amid concerns of defaults, causing yields to rise sharply. Subsequent extensive monetary easing — including the direct purchase of corporate bonds by some central banks — has lowered borrowing costs for companies around the world to below the pre-COVID-19 level.
With a second spike of COVID-19 infections sweeping across Europe, forcing national lockdowns in Germany and France, investors are pricing in their expectation of increased quantitative easing measures by the ECB in December.
"Central banks have been expanding their balance sheets dramatically from the global financial crisis until today. As the economic crisis inflicted by the COVID-19 pandemic intensifies, they will most likely not be able to stop printing money," Althea Spinozzi, fixed income specialist at Saxo Bank, wrote in an email.
The yield on the S&P Eurozone Investment Grade Corporate Bond Index fell from 0.44% to 0.31% over the course of October, reducing borrowing costs below the level for the S&P 500 Japan Investment Grade Corporate Bond Index — 0.48% — for just the second time since February.
Earlier in the year, the yield on the eurozone index spiked from 0.24% on Feb. 25 to a peak of 1.83% on March 25 before flattening in response to a raft of measures by the ECB, including asset purchases, cheap loans and lower borrowing costs for sovereigns and companies.
The spike in COVID-19 cases in September and October and the reintroduction of restrictions on public life have stalled the economic recovery in Europe, yet the ECB held off on further easing at its October meeting, with President Christine Lagarde announcing the bank would undertake a "recalibration of its instruments." ECB watchers expect further quantitative easing to be part of that renewed effort in December, with ING Chief Economist Peter Vanden Houte expecting the bank to unveil an additional €500 billion in asset purchases, providing further demand for corporate bonds.
Fed on standby to control borrowing costs
Reflected in the six regional indexes tracked by S&P Global Market Intelligence, the highest borrowing costs were in the U.S., where the index was 1.84%. Like the ECB, the Federal Reserve is buying corporate bonds, meaning there is a buyer of last resort and implying a ceiling for yields. But with the U.S. corporate bond market much larger than in Europe, where companies prefer to borrow through bank loans, the Fed has a less dominant presence in the bond market than either the ECB or the Bank of Japan.
"While the U.S. economy is still recovering, the U.S. market is likely to continue offering decent yield pick-up compared to other local markets in Europe or Asia," Christian Hantel, senior portfolio manager at Vontobel Asset Management, wrote in an email. "In addition, the cost for hedging currency exposure has been decreasing. This attracted overseas investors, such as clients from Asia into the U.S. dollar market, in particular to investment-grade-rated corporate bonds."
The yield on the U.S. index jumped from 2.1% on March 6 to 4.23% on March 20 before falling back as the number of defaults slowed. The S&P bond indexes for Canada and the U.K. followed similar trajectories, with the two climbing to peaks of 3.2% and 3.5%, respectively, in late-March before falling to 1.74% and 1.69% as of Nov. 9.
In the run-up to the U.S. election, the yield on the U.S. index crept up, reaching 1.9% on Oct. 30 for the first time since July 20. The potential of a long-lasting legal battle over the outcome of the presidential election has been a cloud hanging over markets in recent weeks, but Hantel thinks corporate borrowing costs are unlikely to widen dramatically.
"In case market uncertainty due to a botched U.S. election outcome continues, the Fed could easily restore confidence in the corporate credit market by stepping up its activities under the primary and secondary market credit facilities. Therefore, any spread widening should turn out to be modest and liquidity conditions should remain favorable," Hantel wrote.