We are experiencing a phase on the market the likes of which we have not seen for several decades. The rise in prices in particular is prompting central banks in the West to raise key interest rates significantly. At the same time, there is unrest on the stock market, which has led to prices falling simultaneously on both the stock market and the interest rate market. On the interest rate market, however, the price of bonds will be adjusted quickly. This is because bondholders are entitled to receive coupon interest and repayment of capital. If a company fails to reach an agreement, bondholders can collect the debt and take the company to bankruptcy court as a last resort. Shareholders cannot.
As fixed income managers, we are of course always concerned about bankruptcy risk, but as it stands, the credit margin should have increased sufficiently to take this risk into account. With fixed income funds in particular, investors are seeing that there is a clearer correlation between the risk taken and the return opportunities. If we look at the history of pension funds, there is a clear correlation between the return achieved and the risk associated with the funds. This may also be true in the future. In the fixed income markets, there are two important risk parameters: Interest rate risk and credit risk. With a long-term investment horizon, history shows that investors pay for both interest rate and credit risk over time, but this always entails higher risk and greater volatility.
In Scandinavia, we have limited interest rate risk and have had a shorter-term fixed interest rate than the interest rate index for a long time. In the U.S. in particular, pension funds have seen the biggest drop in pension markets in 30-40 years, with the cause being a fall in prices as a result of surprisingly sharp rises in interest rates. A global benchmark index for bonds has fallen 17 percent this year in dollar terms. The decline will be smaller in Norwegian krone as the krone has weakened. Due to market developments, the fixed interest rate has been increased. We expect that the rate increases will take effect relatively quickly and that the market has already priced in the rate increases we will see. The yield curve, which is the effective interest rate for bonds with increasingly longer maturities, is trending upward. Now it is inverted, which means that the ten-year interest rate is lower than the two-year interest rate in the USA.
The credit risk premium has risen
Over the short term, the situation is very confusing. We know that growth is going to taper off. Credit margins have taken this into account strongly with the increase in margins we have seen so far this year. Prices in the EU are about what we normally see in an average recession. From our perspective, this means that credit margins are attractive if you have a certain investment horizon.
We believe that credit margins are attractively priced in the medium term, but unfortunately we don't know exactly when they will peak. It could get even cheaper than it is today. The effective interest rate is now over five percent for secure corporate bonds and over nine percent for riskier bonds.