ECB buying of corporate bonds reduces the risks of a disorderly market but, with much of the support for business coming in the form of loans, levels of debt are likely to rise. From an index fund perspective, the concern is being a forced seller of debt as it leaves an IG index. The ECB has taken steps to reduce the impact of downgrades to speculative grade through the following measures:
- Not committing to selling non-investment grade bonds from their own purchase portfolio. The ECB has the discretion to hold these bonds to maturity, meaning there will be less of a rush to sell downgraded paper.
- Accepting recently downgraded bonds as collateral in its Eurosystem credit operations. The ECB has said that it will accept assets rated as low as BB, provided they were rated at least BBB- on 7 April. This will continue to be the case until September 2021.
While helpful in smoothing the market impact, these actions do not prevent downgrades. In 2020 so far, Moody’s has downgraded just 7 western European companies to junk, so not very different from the past 4 years. S&P, however, has been more assertive with 11 downgrades, its highest first half total since 2013.
From an index perspective, risks look manageable for the near term. In the Bloomberg Barclays Euro Corporate Bond Index, the number of Baa3-rated bonds (the lowest IG rating) is 218 out of a total universe of 2034. More importantly, of that total only 46, or 2.3% of the index, have a negative rating. For the Bloomberg Barclays 0-3 Year Euro Corporate Bond Index, the proportion is even lower at 2.1%.
S&P’s decision not to downgrade Italy was an implicit acknowledgement that it will wait for more clarity on the economic front. Similar comments from Moody’s may also buy corporates some breathing space. This move, coupled with the currently limited exposures of indices to the most at-risk bonds, should ensure that there is no imminent flood of downgrades.
How to play this theme
SPDR offers two ETFs through which investors can access these themes. To learn more about these funds, and to view full performance histories, please follow the links below:
SPDR® Bloomberg Barclays Euro Corporate Bond UCITS ETF (Dist)
SPDR® Bloomberg Barclays 0-3 Year Euro Corporate Bond UCITS ETF (Dist)