By Yoruk Bahceli and Saikat Chatterjee

LONDON (Reuters – While global stocks are experiencing their worst start since 2016, the U.S. Federal Reserve’s policy-tightening campaign is underway. However corporate credit with little exposure to worst-hit technology companies is proving remarkably resilient.

The U.S.- and European bonds of companies — those with investment-grade (IG), as well as more risky ones with bad credit ratings — suffered the worst January losses since March 2020. But their fall was dwarfed in February by equities where $7 trillion worth of market value fell.

U.S. IG was the worst sector with a 3% decline, however this was less than the 5% decrease.

The U.S. investment grade credit risk premia have risen to a record high for one-year, but they still remain close to levels in February 2020.

The central bank stimulus did not pump up credit as much; U.S. IG debtholders saw 9% returns from 2020-2021 while U.S. equities only returned 47%.

Numerous companies used the zero rate period for refinance and cash raising to raise funds and debt. By September last year, U.S. firms had fallen to levels comparable to their profits.

As economies improve and corporate profits rise, default risk decreases. According to Moody’s (NYSE):, the default rate for junk-grade businesses — companies with credit ratings lower than BBB-minus — was 1.7% by 2021.

It’s 6.9% lower than 2020, but still well below levels of 3.3% pre-pandemic.

GRAPHIC – U.S. corporate bond spreads

https://fingfx.thomsonreuters.com/gfx/mkt/znvnejkdzpl/US%20corp%20spreads%20feb%201.png

However, the main factor for resilience may be what Deutsche Bank (DE:) This is a lack of cross-over between corporate and equity debt indexes. Their constituents, in other words are very different.

Tech shares, which are long-duration assets and are susceptible to rising interest rates, suffered the most from the recent equity selloff.

Deutsche noted that the top 10 U.S. companies — mostly tech firms — comprised 28.5% of the S&P 500 but less than 4% of the IG bond index.

Most top IG constituents do not have any technical skills and are therefore more susceptible to changes in underlying rates.

Deutsche stated to clients that if tech causes a U.S. stock market sell-off credit will be fairly insulated. He also said that the correlations between credit spreads and equity movements had fallen sharply in the last 12 months.

Credit has seen the high-yield index with almost zero exposure to tech outperform its IG counterpart, noted Flavio Cartzano, Capital Group investment director.

Refinitiv Datastream says that the duration of the high-yield debt is approximately five years. This is because it has a lower sensitivity to changes in underlying interest rate movements than the IG Index, which averages around eight-1/2 years.

He said, “It is an environment in which the most sensitive asset classes to interest rates are those that are underperforming so it means tech stocks and (investment grade) credit while other assets such as (high yield) credit are performing better.”

Deutsche Bank estimates that in Europe, 20% of the IG index is made up of 20 companies.

LOW YIELDS

Companies were able to tap markets despite January’s volatility, according to Refinitiv data. U.S. IG bonds sales reached a five year high, according Toretiv data.

Goldman Sachs (NYSE) has released its financial conditions indexes, showing that the jump in inflation-adjusted returns — effectively the true cost of capital — last month coincided with the stock-market sell-off.

Financial conditions are what determine the ease of accessing finance. Markets expect U.S. rates to reach a peak at 2% this cycle, the so-called “terminal rate”.

GRAPHIC: Financial conditions are getting tighter

https://graphics.reuters.com/GLOBAL-MARKETS/GLOBAL-MARKETS/zgvomaqzovd/chart.png

Refinitiv Datastream says that borrowing costs for U.S. IG companies could rise by another 80 bps, before surpassing the index’s par-weighted coupon.

Refinancing debt can help companies reduce interest costs.

John Marley CEO, forexxtra (a London-based consulting firm) stated that markets would keep credit and FX volatility under control as long as the Fed’s dots plot or terminal rate pricing doesn’t change meaningfully above 2%.

GRAPHIC – U.S. IG yield vs Coupon

https://fingfx.thomsonreuters.com/gfx/mkt/gdpzyndrdvw/us%20debt%20refi%20feb%201.png