Credit markets brush off government bond fears

As Creditflux goes to press, the Treasury Department announced plans to buy back up to USD 6bn of government debt, triple the usual buyback amount, in hopes of calming the market.

In response, the US 30-year treasury yield shot up past 5.3%, the highest level seen since the 2008 financial crisis. This comes less than 24 hours after Treasury Secretary Scott Bessent jokingly dared currency traders and credit investors to bet against him as he faced questions around the Treasury’s intervention to bolster the Japanese yen.  

“Whenever people say, well, the Treasury Secretary’s taking a risk, well, it’s my dream,” Bessent said during a fireside chat at the SMU Cox School of Business. “I have asymmetric information, I am the house now... you can bet against me if you want.”

Spiking government bond is not unique to the US. The Gilt is up in the UK. France, Germany, and Japan are also seeing higher cost of borrowing.

“The interest rate markets are telling you that they really are concerned about inflation and to a certain degree concerned about the size of government borrowings,” said Symon Drake-Brockman, co-founder and managing partner at Pemberton Asset Management, on the Credit Exchange with Lisa Lee podcast, taped on 8 September.

Referring to the US-Iran war, he added: “I think the re-engagement of hostilities over the last ten days has really set that theme back in place.”

Separately, in early September, Oak Hill Advisors CIO Alan Schrager told the Credit Exchange podcast that there is fear in the market and investors clearly need to be compensated for this uncertainty. The US and other countries are grappling with their deficits, which have exploded across the globe.

Interest rates are being driven by inflation on the short end and a combination of inflation and fears about debt quantum on the long end.

“People just want to get paid more for what they’re doing, which is in essence raising these bond yields,” Schrager said.

However, the story that deficits are causing rates to stay higher has always been there, he added. The narrative just never sticks because investors start buying more sovereign debt when they feel fear, he said. If the market starts seeing recessionary risk and people move into sovereign debt markets in response, then that will in essence lower rates and prove that investors are willing to ignore the fundamental issue around debt and deficits.

Many attribute a different cause: the huge spending needs to build out the infrastructure for artificial intelligence that is pulling demand away from government bonds. In effect, it’s a crowding out.

“I’m in the credit crowding camp,” Gregory Peters, co-CIO of PGIM Credit told Creditflux. “It’s just beginning. The shifting demand-supply landscape is under appreciated. The quantum of debt for the AI buildout is nothing we have seen before,” he added.

In Europe, there are some jumbo deals ready in the leveraged finance pipeline, said Alex Martin, head of the structured credit and CLO practice group in Milbank’s London office. In the US, meanwhile, a number of deals have already kicked off.

Citi is marketing a USD 1.5bn loan to back the acquisition of facilities management company BGIS by sponsor Veritas, as well as a USD 2.1bn loan for KKR’s take-private acquisition of medical device company Integer.

Most European CLO managers have at least one warehouse, and in some cases several, ready to deploy, Martin said. The investor base is back and focused, and there is an expectation that the final quarter of the year will prove busy.

Even the reset side is gearing up for more activity, Martin noted – with triple As having remained sticky around current levels for the majority of the year and little imminent prospect of significant spread movement, ever more managers are gearing up to rework deals through the end of the year.

For both loans and CLOs, higher rates are constructive as there is genuine structural demand for floating-rate products, Vibrant Capital Partners co-CIO Kashyap Arora told Creditflux.

“Insurance balance sheets in particular find these assets attractive in a higher-for-longer environment,” he said. “On the flipside, it does impact credit fundamentals, in terms of pressuring interest coverage ratios and free-cashflows for companies.”