(Feb 18): Price moves in the global credit market are so calm that some money managers are wondering whether a relentless rally in corporate bonds is becoming a red flag.

A handful, including those at Franklin Templeton Investment Management and AXA Investment Managers, are getting more cautious about corporate bonds. With investment-grade spreads at the tightest in almost two decades, they’ve been reducing allocation to the asset class in favour of government bonds and cash, believing that the meager reward isn’t worth the risks.

These managers are going against the crowd. Flows into corporate bond funds have been unremitting, while systematic traders are “max long the asset class,” according to UBS Group AG. Instead of spreads, these investors are focused on the attractive coupons, or interest income, that corporate debt can offer. That’s meant that even market-moving events like US President Donald Trump’s tariff threats and the potential for fewer interest-rate cuts by central banks haven’t managed to knock credit down.

“When everybody becomes complacent that everything’s just fine, it normally isn’t,” said David Zahn, head of European fixed income at Franklin Templeton. “The chances of a policy mistake in multiple jurisdictions is incredibly high,” he said. Zahn’s total return fund has cut exposure to credit from more than 40% last summer to just under a quarter now, preferring government bonds.

AXA portfolio manager Nicolas Trindade has also been taking a more defensive position. He said that his usual 10% allocation to cash and sovereign debt now stands at 30%, the highest since late 2021.

These asset classes are much more liquid, allowing money managers to jump back into corporate bonds if valuations improve.

“Yields are high because sovereign yields are high, not because of credit spreads,” Trindale said. “But a lot of investors are just all-yield buying. Investors think the Fed will cut, they think Trump won’t do all the things he said he would on the campaign trail.”

Still, for now, investors “can afford to be complacent because the level of yields available are still very high,” he added.

And many have been attracted by that. US high-grade funds saw their strongest inflows in 11 weeks at the start of February, according to EPFR Global data compiled by Bank of America strategists, while European high-grade funds recorded weekly inflows in all but four of the past 67 weeks.

Meanwhile, UBS’ quantitative model showed that systematic traders are also piling in to “keep harvesting carry,” or interest income, a situation that isn’t expected to change in the near term, strategists including Nicolas Le Roux wrote in a note last week.

The broad-based buying has depressed metrics of volatility to the point where movements in risk premiums have rarely been as tranquil in recent years.

Volatility on the cost of protection against default among North American investment-grade companies over a rolling 60-day period is close to its lowest level since 2021 and has been consistently subdued this month, based on data compiled by Bloomberg. It’s a similar picture for volatility measures on key US and European investment-grade indexes and European credit-default swaps.

“This is different to the 2010s. Credit is not a spread product any more but a yield product,” said Raphael Thuin, head of capital markets strategies at Tikehau Capital. “Looking at the fundamentals, it’s a very benign picture. And the technicals are strong, which is why you have so little volatility in spreads,” he said.

Still, spreads are not immune to economic woes and the biggest challenge for money managers will be deciding when to act on those risks.

“The sheer level of uncertainty around trade policy makes any analysis difficult to incorporate into decision making ahead of the event,” Mark Dowding, chief investment officer at RBC BlueBay Asset Management, wrote in a note. “Nonetheless, this leads us to think that there may be some level of complacency in the prevailing status quo in market pricing.”

Joost De Graaf, co-head of the credits team at Van Lanschot Kempen, agrees. “You can decide not to participate as a credit investor but then you need to have patience, because you don’t know when exactly the market will turn,” said De Graaf, who has a slight overweight on credit risk.

“What would the cause of the downturn be? Your guess is as good as mine.”

Uploaded by Siow Chen Ming