Has the corporate bond market partied too hard?

Mark Brooks

Locally the good times are obvious in the number of cranes on the skylines of our major cities and in the difficulty of finding staff. The United States is also seeing similar capacity constraints as labour market surveys show there are more job openings than there are unemployed.

There is a saying that financial bull markets do not die of old age. Instead, they end due to a combination of capacity shortages constraining growth and central banks increasing interest rates to counter the risk of rising inflation.

In the United States this process in now well under way as the Federal Reserve has raised interest rates eight times already and will probably do so again in December. Higher interest rates have tightened monetary conditions in the United States and globally. This squeezes those in a weaker position, primarily those with excessive debt loads and/or economically sensitive incomes. During the Global Financial Crisis this was predominately households in the United States and in New Zealand, non-bank lenders such as finance companies.

This time round, a key area of stress is likely to be the corporate bond market. A decade of ultra-low interest rates forced many investors out of cash as it did not generate a return into other investment assets. Much of this money flowed into the corporate bond market. Globally, companies were more than happy to accommodate this demand by issuing bonds at historically low interest rates. In the United States, this has seen the corporate bond market double in size over the past decade to more than $5 trillion.