A SURGE in the supply of corporate debt in the riskiest investment-grade category may leave markets vulnerable to a rout if economic weakness triggers bouts of rating downgrades, according to the Bank for International Settlements.

The BIS is the central bankers’ central bank and provides policy advice as well as acting as a forum for them.

Investment-grade bonds classed BBB by ratings firms – one step above junk status – have proved popular with funds bound by their own rules to hold only low-risk securities.

While central banks pursued low interest rates and quantitative easing that pumped trillions of dollars into markets after the financial crisis, such bonds offered tempting yields while still falling into the low-risk category that made them eligible holdings.

In 2018, BBB-rated bonds accounted for about 45pc of US and European mutual fund portfolios, up from 20pc in 2010, according to the BIS.

But many investors may have to sell those bonds if they fall out of the investment-grade scale.

If an economic downturn prompts credit-rating cuts, this could trigger a market crash as investors dump the newly ineligible debt from their portfolios, according to the BIS.

“If, on the heels of economic weakness, enough issuers were abruptly downgraded from BBB to junk status, mutual funds and, more broadly, other market participants with investment grade mandates could be forced to offload large amounts of bonds quickly,” wrote analysts at the Basel-based institution in its quarterly report.

“While attractive to investors that seek a targeted risk exposure, rating-based investment mandates can lead to fire sales.”

Bloomberg

Source: Read Full Article