Cracks are opening in the weakest parts of the corporate bond market while record-breaking debt issuance from the largest US technology companies is widening spreads on higher-quality bonds, Aviva Investors head of core income James Vokins has warned.
The manager of the Aviva Investors’ Global Investment Grade Corporate Bond fund, which holds bonds from companies with higher credit ratings, and the Aviva Strategic Bond fund, highlighted government borrowing costs as a particular issue.
Government bond yields have risen sharply this year driven by fiscal deterioration and inflation, which the manager is watching as potential triggers.
“With any move higher in yields, pressures emerge. It doesn’t happen to all sectors and the whole market all at once. Typically, it tends to focus on a few names, and then it might spill over into a few sectors. And then you start to see it come through across the whole market. So that’s exactly the playbook that we’re seeing in credit at the moment,” he said.
“I’m not putting my tin hat on going, ‘This is the end of the credit cycle,’ but there are cracks emerging in areas where there is excessive leverage. And that’s exactly what you would expect from a macro backdrop that is pushing yields higher.”
Indeed, markets are pricing three or four interest rate rises over the next year in Europe, the US and the UK, as inflation stays hot and governments show little appetite for fiscal consolidation.
“Inevitably, there’s going to be casualties on that path of tighter conditions. And we’re in the early stages of that,” Vokins added.
In particular, he named three areas of risk. The first is CCCs and below, the lowest rating band in high yield, where companies are judged most at risk of defaulting on their debts. The other two are technology and telecoms and media, where companies sold a lot of debt while money was cheap and are now being tested by higher borrowing costs.
So far, he said, the damage has stayed within those pockets.
However, even the sectors that have held up best in the current climate, among them healthcare, banks and energy, are not immune. If the weakness continues, Vokins said, they too will come under pressure, because they will have to refinance.
“Those companies and sectors, they still need to issue debt as the course of their day-to-day business. They still need to refinance their debt. And they’ll need to bring deals wider than where they would have been had they issued a year ago. So that’s just going to put pressure on the spreads of those other sectors.”
For now, none of this is yet visible at an index level. Looking at investment grade spreads (the extra yield investors demand over government bonds), there has only been a small move.
You see “little blips here and there but we’re not at Liberation Day wides,” Vokins said, referring to the peak in spreads after the April 2025 US tariff announcements.
“But under the surface there are some fairly large sectors coming under pressure.”
There is pressure in investment grade too, where the five large US technology groups known as hyperscalers are building data centres for AI through debt.
“There’s been record-breaking issuance from those names. They’re growing in concentration in the index. Every time one issues, you tend to see another one come right behind them. And so that continues to push spreads in those names wider and wider”.
For investors, that has meant little reward so far, and it’s been “very difficult for investors to make a positive return out of hyperscaler issuance,” he said.
But while hyperscaler bonds are widening because of the volume of supply, the strength of their balance sheets is intact. In fact, Vokins saw opportunities here, as “you can own a AA credit at a BBB spread in a name like Meta or Amazon or Google and you are able to increase the credit quality of your overall portfolio quite easily without giving up too much spread, which is not something you tend to see in credit. Usually, if you want to go up in quality, you sacrifice spread”.
Vokins holds a few of these tech names at a single-digit percentage of his portfolios, which leaves it underweight against the benchmark. He trades them tactically and looks for value between different bonds from the same company, such as a Meta data centre bond against Meta’s public debt.
How long the supply lasts depends on spending plans the manager is not willing to trust.
“Every time they’ve come to the market, they have increased their capex guidance. So it’s difficult to entirely take the communications at face value,” he said.
“For an equity investor, that’s great because there’s lots of growth potential. But from a credit perspective, we’re the ones funding all that growth, and their balance sheets are being used as the tool to fund that growth. And that’s what we care about. So we’re worried about the downside and the impact of all that growth that has on their leverage metrics and their credit metrics overall.”
In response to his outlook, Vokins has lengthened duration, a measure of how sensitive a portfolio is to interest rate moves. In particular, shorter-dated gilts are one preferred area because the market prices four Bank of England interest rate rises, which he said is high, given the weaker position of the consumer.
Meanwhile, within credit, he is rotating out of healthcare, banks and energy, which have held up because they are out of the spotlight but have “little value left in them”.
“I would be warning multi-asset managers that certain credit sectors are coming under pressure and cracks will inevitably emerge. And so you need to make sure that you’re in the names that you’re comfortable owning over a volatile period ahead,” he said.