“The U.S. recession we forecast in the final quarter of the year, along with the recent collapses of Silicon Valley Bank and Credit Suisse, has heightened the risk of a correction in the U.S. investment-grade corporate bond market,” says Cristian Maggio, TD’s head of portfolio and ESG strategy. “Tighter lending conditions ahead may act as a catalyst for this correction.”
While banks aren’t the largest investors in the corporate bond market, they do play an important role in facilitating trades and providing liquidity for other investors. To do so, banks have to allocate precious regulatory capital and balance sheet — something which is becoming both more scarce and expensive in the aftermath of March’s banking collapses and a wider flight in deposits.
So even though banks own just seven per cent of outstanding corporate bonds, according to TD’s estimates, they could still drive a correction in credit risk premiums that are low by historical standards. Maggio estimates that carry spreads are now just 23 basis points, marking the third-tightest level in data that begins in 1996.
“Banks are important in this context as their sensitivity to interest rates may pressure U.S. investment-grade corporate yields to correct,” Maggio says. “While unfunded investors may be content with a modest yield pick-up over Treasuries, liquidity providers need margins large enough to beat their internal funding costs.”
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