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Why this investor isn't alarmed by higher credit spreads, yet

A picture shows Ratings agency Standard & Poor's logo on a document in their Paris office prior a yearly press conference about 'macro economic outlook and general trends on credit markets, focus on credit condition in France and in Europe by sector' in Standard & Poor's offices in Paris on December 8, 2011
Eric Piermont | AFP | Getty Images
A picture shows Ratings agency Standard & Poor's logo on a document in their Paris office prior a yearly press conference about 'macro economic outlook and general trends on credit markets, focus on credit condition in France and in Europe by sector' in Standard & Poor's offices in Paris on December 8, 2011

Investors in credit markets are demanding substantially higher yields in return for the risk of owning corporate debt instead of haven government bonds. But one investor reckons this may not necessarily portend a wave of corporate defaults.

In a blog post, Toby Nangle, head of multi-asset allocation at Columbia Threadneedle Investments, which manages £320 billion ($495 billion) in assets, noted that while there had been a worsening of certain leverage metrics—corporate gross debt as a share of earnings before interest, tax, depreciation, and amortization (EBITDA) for instance—the shape of the yield curve is sending a less alarming signal.

As Nangle notes, except for highly speculative debt, there is scant evidence of credit spread curves flattening.

Typically, in periods of excessive turmoil in financial markets, yields on short-dated debt rise more than those on longer-dated debt as investors fret over getting back their original investments in the immediate future.

This trend of flattening and inversion of the yield curve played out in Greece during the sovereign debt crisis when yields on near-term bonds surged well above more long-dated bonds. Eventually, Greece ended up restructuring its debt.

In more placid times, yields on bonds maturing further down the line are greater than those on shorter-dated debt as investors expect faster expected growth to lead to higher interest rates and as a consequence, higher yields.

Chart: Columbia Threadneedle

Some market participants have pinned the steepness of the curve to more sales of longer-dated debt. A demand-supply mismatch if you will, but Nangle seems less convinced of the impact of issuance.

"While higher levels of issuance have recently coincided with steepening, we find no stable correlation between curve shape and issuance trends over the last 20 years and so find such arguments inconclusive," Nangle says.

Investors seem relatively certain about the good near-term prospects of the market in general but have heightened uncertainty about credit conditions further into the future, according to Nangle. This is true for both European and U.S. credit markets.

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In addition, the recent stock market fall coincided with the latest spike higher in high-yield corporate bond yields – taking these higher than one-year and two-year global equity earnings yields for the first time since the global financial crisis and undermining the equity market's status as the highest-yielding risk market, he says.

"Investors are left with asset markets containing elevated risk premia across the piste, which makes for a more constructive investment environment, but also diminishes the attraction of equities as an asset class," Nangle says, adding that Columbia Threadneedle has slightly upped its exposure to European high yield debt.