Investors are starting to see companies as a safer bet than countries.
Something odd has been happening in the bond markets of the developed world recently. In the US, UK and parts of Europe, corporate credit spreads have been tightening relative to government bonds. It is not unthinkable that one day, some companies could trade at yields lower than their sovereign counterparts.
In this scenario, investors would see debt issued by a company as less risky than that issued by a government — an idea that would have seemed fanciful to me for much of my career and an astonishing turn of events. It is not imminent, but it is no longer unimaginable.
Government bonds — especially US Treasury bonds — are the archetypal safe haven, the lowest of low-risk investments against which all other asset prices are benchmarked. If corporate piggy banks could potentially be viewed as sturdier bets than a country’s coffers, this would challenge some of the fundamental principles of investing.
Markets don’t lie, so why are corporate and government bonds slowly, but perceptibly, beginning to resemble each other? Covid is not a word many of us like to use much nowadays, preferring to leave memories of lockdowns, DIY haircuts and home-made banana bread in the past. But this gradual costume swap between government and corporate debt is another example of the legacy of the pandemic continuing to affect economies
As Covid spread in 2020, governments borrowed massively to fund stimulus measures that propped up companies and households. Simultaneously, companies pocketed what was in essence free money to shore up their businesses, pay debt and bolster cash buffers. All of which means they look in fairly rude health today.
Put simply, governments transferred trillions from their own balance sheets to those of companies. Corporate balance sheets are the strongest they have been in 50 years.
On top of this, the emergence of private debt as a source of alternative credit has been one of the main investment stories of the past few years. The private debt market is worth about $3 trillion (£2.4 trillion) and predicted to grow rapidly. With all this money sloshing around, businesses requiring capital have plenty of options, making their debt somewhat less risky. Even companies that should probably topple over will be propped up.
Governments do not have the luxury of these new, and swelling, borrowing options. And, like well-intentioned parents who transfer all their cash to their kids and leave themselves penniless, they have been left with ballooning deficits and spiralling interest payments. If central banks embark on their expected rate-cutting cycles, sovereign yields may fall but, while that will reduce interest payments, it won’t cut government deficits. A distinctly unimpressive combination for investors.
It’s hard to see how governments get off this debt treadmill. While not fully steaming ahead, the US economy is chugging along nicely — but the deficit is rising, not falling. Growing its way out of a fiscal hole isn’t working. If this is the case in a relatively healthy, higher-growth economy like America, the prospect of a surge in productivity riding to the rescue in the UK or Europe seems even more remote.
If we were eventually to enter a strange new world where corporates become seen as safer borrowers than governments — thereby holding even more of the ammunition needed for economic growth — one potential consequence would be that the relationship between them shifts. We may see governments needing to secure the approval of businesses for their policies, rather than simply imposing them — increasingly asking for permission rather than forgiveness.
Perhaps this scenario is closer than we think. If aliens studied the recent photograph of BlackRock’s chief executive, Larry Fink, sitting opposite Sir Keir Starmer at Downing Street during Labour’s efforts to woo business, there’s no doubt who they would assume is in charge — and it’s not the elected leader. The former is a picture of quiet authority while the latter resembles a diminutive and rather needy middle manager.
Rock-solid balance sheets and sky-high cash piles provide corporates with seemingly impregnable defences against market slowdowns and shocks. Conversely, as deficits continue to grow, governments’ defences become ever more vulnerable to vigilante justice from the bond markets.
Whether the debt of the world’s most powerful companies displaces that of big governments as the go-to safe haven is, for now, more a philosophical question than an imminent tipping point. Nevertheless, the trend towards government borrowing becoming costlier than blue-chip borrowing looks set to stay. This should not only be a wake-up call but could herald the start of a shifting dynamic between the public and private sector.
Seema Shah is chief global strategist at Principal Asset Management