(Bloomberg) --
Yields on the safest sterling corporate bonds have risen above their pandemic peak just as Bank of England policy makers weigh lifting rates to their highest level since the global financial crisis.
Investment-grade yields ended Tuesday at 3.6%, surpassing the high of 3.56% reached at the start of the coronavirus crisis, based on Bloomberg indexes. Company funding costs are surging on the back of a jump in U.K. government bond yields as markets brace for more rate hikes.
The milestone highlights the turbulence in markets as borrowers contend with the highest financing costs in years and investors nurse big losses on their bond holdings. With central banks preparing to further tighten policy still further to bring runaway inflation to heel, the situation looks poised to get even worse.
“Clearly if we're talking about 6, 7, 8% levels of inflation, it's hard to see a quick turnaround for yields,” said Shalin Shah, a credit portfolio manager at Royal London Asset Management, which oversees 159 billion pounds ($198 billion). Predicting when the market's focus switches from inflation to a higher risk of recession is “like a toss of the coin” that may not occur for the next three months, he said.
Bank of England policy makers are due to meet on Thursday against a backdrop of mounting alarm over the cost-of-living crisis buffeting the U.K. Consumer prices in the U.K. are rising 7% year-on-year, more than three times the Bank of England's target of 2% as inflation hits its highest level in about 30 years.
It's a similar tale in the U.S., where the Federal Reserve is expected to boost rates by 50 basis points for the first time since 2000 this week. Traders will be watching closely to see if Chairman Jerome Powell gives any hint about whether a 75 basis-point hike, which would be the most aggressive move in nearly three decades, could be on the cards for June.
Read more: Traders Price Near Even Odds of 75-Basis-Point Fed Hike in June
Rising Rates
The U.K. central bank has already reversed the cuts that supported the economy through the pandemic and another hike would take the key rate to its highest level in more than 13 years. The BoE has lifted its key rate at its last three meetings and market pricing suggests another 25 basis-point increase to the policy rate, which currently stands at 0.75%.
Against this backdrop of more aggressive tightening, the sterling credit index has already lost 10.2% in terms of total return this year. The gauge has never produced a double-digit annual loss in its 23-year history.
Still, while the risk premiums of sterling high-grade bonds over government debt have risen about 50 basis points this year to 167 basis points, they're still at only about 60% of the peak they reached at the early stage of the pandemic.
However, the BOE will increasingly need to weigh the need to take the fight to inflation against the risk of plunging the economy into recession.
“If there's an advanced economy that's more at risk of falling into a recession it's the U.K.,” Sanjay Raja, a senior economist at Deutsche Bank, wrote in a note to clients on Tuesday. “Limited fiscal support to offset record-breaking energy price rises, tax rises, and a sizeable cost-of-living crisis shrinking real disposable incomes at a historic rate, all mean that the MPC will want to carefully calibrate its moves going forward.”
Elsewhere in credit markets:
EMEA
Financials are leading the European primary market on Wednesday as deals from SEB AB, La Banque Postale Home Loan SFH and Hypo Vorarlberg Bank push the week's issuance to a minimum of 8.6 billion euros ($9.1 billion). Issuers and investors across the continent are waiting to see how the U.S. Federal Reserve plans to tackle inflation across the Atlantic ahead of the BOE's meeting.
- A two-part dollar-denominated higher yielding social-bond deal from Bayport Management may price today, with a three-year tranche offered with a yield of about 12.5% at initial price talk
- April was the second-worst month in a decade for European-high grade bonds after March 2020, with the index posting a 2.75% total-return loss, according to Bloomberg Intelligence
Asia
Dollar bond sales in Asia ground to a halt on Wednesday as companies and investors awaited the Fed's pivotal policy meeting. Little action is likely in the region's debt markets this week, with public holidays in Japan, China and Indonesia today.
- India's central bank voted to raise its benchmark interest rate by 40 basis points to 4.4%, with its 10-year yield rising to the highest since 2019
Americas
The Fed is expected to raise by 50 basis points on Wednesday, its biggest hike since 2000, while also detailing plans for the reduction of its balance sheet. Two companies sold investment-grade bonds in the U.S. on Tuesday, after multiple companies stood down Monday and had been expected to try again.
- Volatility has thwarted many potential issuers from selling new bonds over the last couple of weeks as syndicate desks work to help clients navigate through tumultuous swings in asset prices
- Medical-device manufacturer Bioventus Inc. withdrew its junk-bond deal as market conditions were “not conducive” for offering terms that would be in the interests of its stakeholders, according to a company statement
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