Investors and analysts are beginning to wonder for how long the sterling corporate bond market can sustain its rally in light of recent negative credit events, such as the Enron bankruptcy. "This has been an incredible rally. But you have to ask when it is going to stop. We've seen a huge sovereign default [Argentina] and several corporate defaults. If this continues, we are going to see fundamentals deteriorate rapidly," argues Andrew Burton, credit analyst in the Royal Bank of Scotland's financial markets division in London.
Burton expects the 10-year portion of the gilt yield curve to flatten by 10 basis points over the next few months--from 4.9% to about 4.8%--which would send swap spreads out by about 8.5 basis points, in turn leading to spread widening in the corporate market.
Traditionally, sterling-denominated corporate bonds have not been affected by a sell off in bonds from the same issuer in other currencies, saysToby Nangle, investment manager at Baring Asset Management in London. "The sterling market is more pondering. People are used to taking their own view," However, this could change as more investors, including Baring, take a multi-currency view towards credits--treating companies with dollar-, euro- and sterling-denominated paper as the same story, not as three separate ones.
However, Anna Lees-Jones, fund manager at M&G Investments, who manages a £1.2 billion corporate bond portfolio in London, says she is not worrying about a dramatic plunge in the sterling market. Supply continues to lag behind demand, especially as pension funds and insurance companies rotate out of equity investments and into the corporate bond market. As a result, M&G will hold onto its sterling positions, which include British Telecommunication's 7 1/2% notes of '16.
Furthermore, Lees-Jones says the bad news is behind the market, which has already begun to anticipate an economic recovery. While there may be some more bad news from corporates in the offing, she expects overall improvements.