Sovereign debt concerns in Europe have eased for a time but they could still weigh on US debt capital markets and put a chill on merger activity if worries persist about global growth. Since concern about sovereign risk in Greece, Spain and Portugal swept through the markets last month.
US corporate bond issuance has slowed to a trickle, borrowing costs have risen and at least half a dozen bond sales have been put on hold. Yield spreads on Greek, Portuguese and Spanish bonds have eased from recent peaks since euro zone leaders pledge support for Greece, but the country still faces a crucial test when it sells debt next week.
If debt costs rise for Greece and other euro zone countries or if tightening fiscal policies dampen growth, US credit markets may not be impervious, strategists said. "If governments are paying a higher cost of capital, then investment-grade corporates likely will also and that will tend to dampen economic activity," said Christopher Garman, founder of Garman Research in Orinda, California.
Future bond sales, initial public offerings and mergers and acquisitions could also slow, said Harris Smith, a managing partner with Grant Thornton's private equity group. "It's definitely going to impact how deals get done," Smith said. "There's a little more realism now."
Credit markets have begun to heal this week, with yield spreads tightening after data pointed to strong US economic growth. But if sovereign debt woes slow growth in Europe, a number of US corporate borrowers will be directly exposed because of their heavy reliance on European markets for exports, strategists said.
Dow Chemical Co, Johnson Controls and Bunge Ltd are among companies that derive more than half their sales from foreign markets, a good part of them in Europe, Morgan Stanley said in a recent report. "Should sovereign risks lead to downside revisions to growth and earnings expectations, this would likely hit Europe the hardest," Morgan Stanley said.
"Credits that have rallied over the last few months on expectations for a strong economic recovery, especially those leveraged to Europe, would suffer the most." Bonds of Xerox Corp, for example, have rallied nearly 30 percent to premiums above 100 cents on the dollar. The company gets about one third of its sales from Europe, and also has about 27 percent of its bonds coming due through 2012, Morgan Stanley noted.
Investors are not yet worried that another bear market in corporate bonds is imminent, partly because of the sea of cash still being invested in bonds. "There's $3.2 trillion in US money market funds earning zero percent; that mountain of cash has been whittling down and bond funds have been a huge beneficiary of that, primarily investment grade," said Arnold Espe, vice president of fixed-income research with USAA Investment Management Co in San Antonio, Texas.
Corporate balance sheets are also relatively healthy, earnings are recovering and companies' have taken aggressive steps to cut costs, said Mueller of Wells Capital Management. Still, sovereign risk has reminded the markets that credit problems in the private sector have not been cured but instead shifted to the public sector through government deficit spending during the global credit crisis, he said.