Concerns mount over low-rated European debt defaults | IMF: Private credit growth could pose stability risk | Wider participation changing risk transfer market dynamic
Traders are adjusting their expectations for Federal Reserve rate cuts in 2024, now predicting just two quarter-point reductions, down from the previously anticipated three. This shift follows resilient US economic data and Federal Reserve officials' signals against the need for immediate easing, setting the stage for a pivotal response to upcoming inflation reports.
Investors are demanding increasingly high premiums on CCC-rated European corporate debt as concerns mount that a default cycle may be imminent. Over the last two weeks, yields on European debt reached their highest levels since the coronavirus pandemic lockdowns.
The rapid growth of the $2.1 trillion private credit market could pose risks to broader market stability, the International Monetary Fund said, citing infrequent valuations and questions over credit quality among the chief risk factors. "[T]he migration of this lending from regulated banks and more transparent public markets to the more opaque world of private credit creates potential risks," IMF analysts wrote in a blog post.
Participation in the synthetic risk transfer market has expanded beyond a handful of banks to include broader syndicates including large asset managers, private equity firms and non-specialist credit hedge funds. Long-time market participants are growing concerned that what was once a culture of trust in risk-sharing trades will give way to more competitive and transactional dynamics.
The European Banking Federation says US banks will have an advantage over their EU counterparts because of the US' less restrictive regulations on reporting environmental, social and governance risks. EU banks are subject to ESG-adjusted capital requirements and more stringent disclosure rules.
Recent estimates suggest that the maturity dates of some commercial real estate loans have been extended to this year. PGIM Real Estate notes that banks' expected commercial real estate maturities for 2024 are 35% higher than a previous estimate. Meanwhile, Autonomous Research says that about 40% of banks' CRE loans that are maturing this year were originally supposed to mature last year.
Leveraged loan markets bounced back in the first quarter as borrowing reached near-record levels. Troubled leveraged loans are also on the rise, according to a recent report from banking regulators, with more than 25% of below-investment-grade leveraged loans flagged for concerns, a more than 33% increase from a year earlier. Pitchbook data on leveraged loan borrowers' interest coverage ratio, a cash flow metric, shows borrowers' excess cash falling since the start of the Federal Reserve rate-hike cycle.
US investment-grade firms have issued hundreds of billions in debt so far this year, as a strong US economy and expected rate cuts fuel investor demand. Issuance of sustainability-linked bonds, however, is down significantly from the previous year amid uncertainty surrounding the market. Convertible bond issuance is booming as favorable conditions provide companies with lower spreads, but experts note such issuance can lead to future dilution of ownership.
European Central Bank officials are laying the groundwork for potential interest rate cuts, with the initial reduction expected in June as inflation eases closer to the 2% target. Discussions are underway on whether to continue with a subsequent cut in July or to wait until September, reflecting differing perspectives within the Governing Council.
The Federal Reserve and other US regulators reportedly have taken a stance against incorporating climate risk into global financial regulations, challenging an international effort led by the European Central Bank. The move reflects the Fed's adherence to its traditional mandate, affecting the Basel Committee on Banking Supervision's ability to globally unify standards on climate risk management.
The European Central Bank has awarded Tradeweb Markets two framework agreements to supply electronic trading platforms to the bloc's central banks for the next four years. The platforms will cover euro-denominated bonds -- including European government bonds, covered bonds and repo -- as well as US treasuries, Japanese government bonds, US dollar- and euro-denominated supranationals, sovereign and agency bonds. Bloomberg was also awarded three framework agreements covering a similar slate of products plus Japanese interest-rate swaps and yen-denominated futures.
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