Through it all, the gilt market has gyrated in tandem with the political headlines. Last Friday, Chancellor Kwarteng was fired and later in the day the prime minister gave a speech with U-turns but didn’t go far enough to convince the market. UK gilt yields were down 38 basis points in the morning and up 24 basis points at the end of the day, an intra-day rise of more than 60 basis points. For a government bond to move that much in a matter of hours is astonishing. And for the first time since 1992, politics is being governed by financial markets.
The new Chancellor Jeremy Hunt appears to have steadied the ship by ripping up practically all the so-called ‘mini budget’, alleviating some fears and, as a result, gilts have rallied. That’s not to say that volatility won’t continue. The next event will be the 31 October medium-term fiscal plan with OBR forecasts. I have seen an estimate that volatility in the gilt market has caused losses in UK pension funds through their Liability Driven Investments (LDIs) of £150bn so far.
Understandably, high-yield credit in sterling has been under pressure. Nevertheless, in the higher quality BB-rated issuers, we believe there are opportunities. For example, in the telecoms industry where companies are asset heavy, can pass on higher costs to consumers, operate in a mature market and are cash flow generative. Their default risk should be very low. The bond prices are attractive, they offer high single-digit yields, and as such I believe they could offer good returns on a one- or two-year view.
For the bulk of the year, the market for new issues in European high yield credit has been practically shut. That’s because of Ukraine, higher rates, and volatility in markets. In the last few weeks, we have seen a few new issues test the water, and there have been changes in debt financing that reflect the new rates environment.
For example, we saw a European single-B company refinance a €500m 2024 bond that paid a coupon of 3.5%. The new bond had a similar structure, €500m and a 5-year maturity, but the coupon was 9.25%. That adds €30m to the issuer’s annual interest costs. For companies with a large amount of debt and short-term maturities, their capital structures will be untenable at those levels.
I think we are going to see default rates pick up, as well as company debt restructurings. We have begun to see that in a handful of companies already.
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