As Credit Markets Party on, Citi Says Fun Is Close to Ending

(Bloomberg) -- It might be time for corporate-bond investors to take off their party hats.

Sure, prices are at their highest levels since 2014 relative to Treasuries, and companies looking to sell debt are finding torrid demand. But signs are emerging that corporate debt globally doesn't have much more room to run, Citigroup Inc. strategists led by Matt King wrote in a note March 3. 

“You have this slight puzzle that the markets have taken all of the positives and none of the negatives,” King said in a phone interview Friday. “There's something overly exuberant about that.”

King and his team lay out seven reasons why it may be time to lighten up in the $11.3 trillion market for investment-grade corporate bonds worldwide:

1. That potential March interest-rate hike in the U.S.

Investors have been pouring money into global credit funds, particularly ones that buy U.S. dollar-denominated debt. The current pace of inflows doesn't look sustainable to the strategists, who wrote “each and every additional basis point in risk-free yield is likely to make investors think twice about the risk they are running in order to generate return elsewhere.”

2. Real yields may rise

While yields have spiked since President Donald Trump's election in November, “almost all of the action has been inflation (and growth) expectations,” the strategists wrote. Rising real yields have historically weighed on credit. That's not good news for this rally, which already looks “out of whack” at lower real yield levels.

3. Central banks worldwide are taking their feet off the gas

The European Central Bank and Bank of Japan are already easing up securities purchase programs that have been close to record-high levels. Those reductions are “set to diminish further,” the strategists wrote.

4. Chinese investment isn't sustainable

Around 80 percent of private sector credit creation now is coming from China, the strategists wrote, though they don't believe that expansion is sustainable, given that “the absolute rate of growth is already so high” in the nation and credit creation tends to reach a seasonal peak in January.

5. Global growth prospects look iffy

Yes, corporate earnings are improving, along with global growth and inflation data. But the Citi strategists said they're “skeptical” that we'll see growth acceleration from here. “Economic surprises have a natural tendency towards mean reversion,” and are already declining in the U.S. And while U.S. companies are showing “an encouraging improvement in leverage,” they have yet to show “significant revenue growth.” Trump's light-on-details talk of infrastructure spending, coupled with “contentious” attitudes toward fiscal reform in Congress, are “dimming” the chance that new policies will boost growth.

6. European political risk “refuses to die”

Populist movements and political uncertainty are gripping France, the U.K., the Netherlands and Italy. “We still see too little by way of premia across markets to compensate investors for the potential risks,” the strategists wrote. They say further rallying will only elevate investor vulnerability.

7. Valuations look stretched

“Do you really want to buying credit at post-crisis tights?” the strategists wrote. The U.S. stock market is at valuations last seen in the late 1990s and in 1929, by one metric. They recommend selling and “waiting for a better entry point” as opposed to continuing to pile in.

To contact the reporter on this story: Claire Boston in New York at cboston6@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Dan Wilchins, Kenneth Pringle