BBB corporate bonds, the lowest investment grade rating band in which a company's debt rating can reside, have now grown to make up more than half of the entire global investment grade (IG) market.
Italian sovereign debt
When it comes to the Italian government debt and its BBB credit rating, I am less constructive.
Just over 25 years ago, Standard & Poor's awarded Italy its first foreign currency long-term debt rating of AA+.
Since then, S&P has downgraded Italy eight times, culminating in a rating of BBB- in 2014.
In November 2017 the trend changed. For the first time ever, S&P upgraded its rating for Italian debt by one notch to BBB with a stable outlook. They cited the strengthening economic outlook, an improvement in government finances, and the resolution of some of the problems in the banking sector.
Then in March 2018, the Italian elections resulted in a populist and polarised coalition government. The new coalition produced a three-year economic plan, complete with an increase in the budget deficit via increased fiscal spending, and wildly optimistic estimates for economic growth.
The European Union and bond markets did not react favourably, and the likelihood of a potential ratings downgrade to HY has increased meaningfully.
The implications of the world's third largest sovereign bond market moving to HY status are enormous. The flight of capital from Italy could be vast.
History suggests that ratings agencies are generally slow to downgrade credit ratings. That is why investors need to decide whether the facts support an IG rating.
Despite a more dovish European Central Bank recently, I believe there is more volatility ahead, given still overly optimistic growth projections: Italian banks' reliance on the new TLTRO extension (remember banks are a large part of the domestic buyer base for BTPs); and the potentially erratic behavior of inexperienced politicians with an eye on sole party control after May's European elections.
That is why I continue to be happy to sit on the sidelines of this "it's all or nothing" BBB market.
Debbie King is investment manager at Kames Capital
Equities overweight down to 3%
Relates to 136 million transaction reports
Patience must be a watchword
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