European bond yields are worse than during the 2008 financial crisis

By all statistics, this is the worst sell-off of corporate bonds in Europe in decades, surpassing even the 2008 financial crisis.

Whether you're looking at returns, the rate at which yields have risen, or the length of a sell-off, investors are facing a historic blow. The European Investment Grade Debt Index has fallen for seven straight months, the longest streak of losses since its inception in 1998. The 12.9% loss over the past 12 months is also the worst in its history.  

The fall, a dramatic turnaround after three decades of mostly favorable markets, is the result of central banks around the world tightening monetary policy in an attempt to curb rising inflation.

"We've been in decline for most months this year," said Kyle Klock, senior finance manager at Fisch Asset Management.

The sell-off is more intense than the two comparable periods: the start of the Covid-19 pandemic, which lasted only a few weeks before central banks calmed markets, and the great financial crisis, which was a series of "sharp, rapid drops." 

Investors are now trying to sort out how many rate hikes have already been valued in the market, and therefore how long the rout of corporate bonds will last. 

U.K. inflation was 9.1% on Wednesday, with traders betting on a 160 basis point tightening by the Bank of England this year, while economists forecast the U.S. Federal Reserve to raise its base rate by 75 basis points again in July and the European Central Bank to end negative rates this fall. 

ECB Governing Council member Mario Centeno said on Friday that the normalization of the ECB's monetary policy will be carried out gradually. That outlook hasn't stopped European fixed-income funds from surviving their worst week of outflows since March 2020, according to EPFR Global data cited by Bank of America analysts.

"This is probably one of the most challenging years we've been in, but also one of the most exciting in terms of asset management," said Gregoire Pesquez, head of the global credit team at Amundi SA, Europe's largest wealth manager.  "Given that liquidity still exists, there are opportunities that can be found and increase attractiveness in terms of profitability." 

Meanwhile, recession indicators are flashing, and copper prices, which are considered leaders in the global economy, are falling to a 14-month low. 

For bond watchers, the higher borrowing costs faced by corporations will only put more pressure on the economy's brakes. "We can see that profits have suffered because of this rather unexpected rise in the value of debt," said Timothy Rahill, credit strategist at ING. 

The average yield on euro corporate bonds rose 2.9 percentage points this year to 3.4%, according to the Bloomberg index. This compares with an increase of 1.62 points in 2008, the next largest. 

There is one way in which corporate bonds performed worse during previous crises: for example, the spread between what borrowers paid and the benchmark rate increased during the eurozone debt crisis of 2010-2012.

But it exacerbates the problem for bond investors; Unlike at the time, basic benchmarks such as the German Bunds have also sold off sharply now, leaving them with little room to invest their money. And even here, options-adjusted spreads rose above 200 basis points on Friday – a level that had previously been observed almost exclusively when a major risk event occurred. 

As corporate bonds begin to mature in this environment, a spike in borrowing costs will really make itself felt, both in credit ratings and in companies' ability to repay their debts.  

"In other words, more downgrades and more defaults," said ING's Rahill. 

There were no new deals in the EMEA region on Friday after a week in which issuance exceeded expectations amid widening credit spreads and concerns about a potential recession began to emerge. 

Asian high-quality spreads on dollar-denominated bonds widened for the second day in a row as recession concerns undermined investors' appetite for risk, and it also slowed activity in the primary market on Thursday.

U.S. investors in high-quality bonds have been pulling money from funds that have been buying debt for 13 consecutive weeks, extending the longest streak of losses in history.