Europe Bond Investors Lose in May as End of Cheap Cash Signaled

Investors lost money in European corporate bonds for the first time in four months in May on speculation central banks will stem the flow of cheap cash that pushed borrowing costs to record lows.

Returns on investment-grade notes dropped to minus 0.5 percent for the month, compared with a 1 percent profit in April, according to Bank of America Merrill Lynch’s Euro Corporate index. Junk debt lost 0.1 percent after earning investors 2 percent the previous month.

Signs the global economy is recovering from the worst crisis since the Great Depression are prompting investors to brace for cuts in central bank stimulus programs. Federal Reserve Chairman Ben S. Bernanke said last week the pace of asset purchases could taper off if there is continued and sustained improvement in economic growth, while economic confidence in the euro region increased in May.

“Markets are anticipating the end to quantitative easing and therefore the crutch that it’s provided credit markets in keeping rates low will disappear and less liquid bond markets will sell off,” said Bill Blain, a strategist at Mint Partners Ltd. in London. “Already bonds priced off government benchmarks are under-performing in line with the rising rate environment, and it could get more pronounced.”

The average yield on European corporate bonds rose 12 basis points from a record low of 1.72 percent reached May 17, according to Bank of America Merrill Lynch’s Euro Corporate index. The premium investors demand to hold that debt instead of government bonds is holding near 112 basis points, the lowest since November 2007.

Worst Performers

Telecom Italia SpA’s bonds were the worst-performing investment-grade securities in Europe, with investors in the country’s biggest phone company losing an average 2 percent over the month, Bank of America Merrill Lynch data show. Rexel SA, the French electrical equipment distributor, offered the poorest returns among junk-rated securities, with an average 1.5 percent loss, the data show.

ING Groep NV, the Netherlands’ largest financial-services company, led companies selling 56.7 billion euros ($73.4 billion) of bonds in May, compared with 66.2 billion euros in April, data compiled by Bloomberg show.

Speculative-grade borrowers including U.K. fashion retailer New Look Group Plc and Frigoglass SA, the Greek refrigerator equipment supplier, raised 8.6 billion euros of debt, compared with 10.4 billion euros last month.

Junk Record

Investors bought a record 46.6 billion euros of junk debt this year, according to data compiled by Bloomberg. The extra yield they demand to hold the notes reached 454 basis points on May 10, the lowest in 5 1/2 years, and was at 474 on May 30, Bank of America Merrill Lynch data show.

“The fact that high-yield bonds have tightened so much, while remaining quite illiquid, means they’re mis-priced,” said Blain. “Investors who have neglected the fundamentals of credit and liquidity are about to be reminded why corporate bonds are more risky.”

In Europe’s credit markets today, William Hill Plc, a U.K. operator of more than 2,300 betting shops, is selling seven-year bonds in pounds that will yield about 4.25 percent, according to a person familiar with the deal. The company, which last sold debt in 2009, is rated BB+ by Standard & Poor’s and Ba1 by Moody’s Investors Service, one level below investment grade.

Credit Derivatives

The yield on the company’s 7.125 percent bonds due November 2016 has fallen 98 basis points this year to 3.1 percent, below the average 5.5 percent investors demand to hold sterling bonds rated BB, Bank of America Merrill Lynch index data show.

The cost of insuring European corporate debt against default rose this month after reaching the lowest in two years on May 22. The Markit iTraxx Crossover Index of default swaps on 50 companies with high-yield credit ratings gained 23.5 basis points this month to 420 at 10:54 a.m. in London. The measure fell to 366 on May 22, the lowest level since May 2011.

The Markit iTraxx Europe Index of contracts on 125 investment-grade companies rose five basis points this month to 104. It reached a three-year low of 87 basis points on May 22.

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers increased four basis points to 150, while the subordinated index fell 19 basis points to 215 after reaching 177 basis points on May 22, the lowest in almost three years.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.