The worst is yet to come for US credit markets
Survey: Tighter monetary policy is big risk to sector
NEW YORK: The ugliest year ever for US corporate-bond investors is expected to get uglier – and they only have the Federal Reserve (Fed) to blame.
With the central bank raising interest rates at the fastest pace in decades, nearly three quarters of those who responded to the MLIV Pulse survey said that tighter monetary policy is the biggest risk facing the corporate-debt market.
Just 27% were more concerned that corporate bankruptcies will pile up over the next six months.
The results underscored the bittersweet outlook for fixed-income investors that were hit during the first half of the year with the deepest losses since at least the early 1970s.
The survey included responses from 707 investment professionals and individual investors.
On one hand, they don’t think the troubled run is over, with more than three quarters anticipating that yields this year will widen to new peaks over Treasuries.
But, at the same time, a majority expects the downside to be relatively limited.
They predict that spread – a key gauge of the extra compensation demanded for the perceived risk – will hold well below the levels seen during the March 2020 Covid crash or the recession set off by the housing market downturn.
“There is definitely much more downside, or risk, to widening from where we are right now,” said Kurt Daum, senior portfolio manager at USAA Investments, a Victory Capital franchise.
Yields on corporate bonds have edged steadily higher over Treasuries during the waves of selling that raced through fixed-income markets this year.
That spread on investment-grade corporate debt reached as much as 160 basis points (bps) in July, according to Bloomberg’s index, before pulling back slightly.
But the relatively muted spread increases anticipated ahead show investors expect the corporate-finance market to avoid the kind of stress that followed the 2007-2009 recession, when investment-grade yields surged to more than 600 bps above Treasuries.
In March 2020, that gap hit nearly 400 bps, prompting the Fed to step in to ensure that a lack of available credit didn’t deal another hit to the economy.
The outlook likely reflected the strong position many companies are in after profits surged on the back of pandemic-related stimulus and two years of rock-bottom interest rates.
Despite speculation that the United States is veering toward a recession, on Friday the Labour Department reported that hiring unexpectedly surged in July by the most in five months, underscoring that the economy remained strong despite the Fed’s aggressive monetary policy tightening.
As a result, some 86% of survey respondents said that companies were better positioned to weather a recession than they were in 2008.
That’s in part because many businesses refinanced their debts after the Fed slashed rates in 2020.
Still, the strong balance sheets aren’t expected to be enough to prevent further losses, particularly for junk bonds, which would be more sensitive to an economic slowdown.
Yields haven’t likely peaked yet and may rise beyond the nearly 9% high in late June, respondents said.
Such risk means that some bonds, like those in the CCC ratings tier, among lowest rung of junk status, are not as attractive as more highly rated securities.