No ‘credit bubble' in sight, says F&C's Seabrook

Despite the growing debate amongst fund managers and industry commentators on the potential emergence of a speculative bubble in credit markets, this is actually far from being the case, according to Rebecca Seabrook, Director, UK credit at F&C.

She highlighted a number of factors which lead to this conclusion, including the current level of credit spreads, the flow of new issuance, quantitative easing, increased risk controls from institutional investors and market dislocation and a polarisation across sectors.

"The current debate seems to have started because spreads narrowed quite sharply in a relatively short space of time at the end 2008 and into 2009. But this shows investors looking to benefit from the attractive valuations on offer as a result of the indiscriminate fall-out across all sectors resulting from the credit crunch and banking crisis," Seabrook commented.
In the first two months of the year we have already seen around £25bn of new issuance.

"With bank lending still frozen and therefore effectively closed to many potential borrowers, this is a trend that is set to continue as more and more companies turn to the credit markets to raise finance. Such a flow of new issuance will increase supply in the market reducing the build-up of any ‘speculative pressure'," she added.

Quantitative easing could follow ‘credit crunch' and almost become part of everyday language. The Bank of England has announced that it will inject £75bn into the UK economy by directly purchasing securities.

"Originally this was thought to involve predominantly corporate bonds, but it will actually include gilts, commercial paper, paper issued under credit guarantee, syndicated loans and some asset backed securities. Understandably, the response of corporate bond markets has been fairly muted," she said.

Seabrook also believes that, as part of the fall-out from the credit crunch and the effective freezing of credit markets, there will be increased attention on risk management by the big institutional investors including both life and pensions funds. This may, in fact lead to a lower weighting towards credit overall, which could see a slowdown in the demand for corporate bonds.

"The current market conditions are clearly focusing on risk and quality, with poorly performing companies seeing the value of their bonds punished severely. It is this disparity in performance which shows we are not in a speculative bubble. We are still in a highly uncertain environment and certainly bond values will over-shoot on both the upside and downside, creating opportunities for both selling and buying".

She concluded: "Speculative bubbles tend to build over time as more and more investors start to follow the same sorts of trades and in an environment with a limited supply of investments. We feel we are a long-way from such a case with, in particular, the supply of new issuance set to increase and the clear polarisation of performance across sectors and quality. We need to see a normalisation of markets before we are likely to see the development of any speculative bubble".