U. S. Corporate Bond Growth Loses Momentum
2023.01.25 12:03
U. S. Corporate Bond Growth Loses Momentum
By Tiffany Smith
Budrigannews.com – Some investors are becoming skeptical of recent optimism about a “Goldilocks” economic scenario of slowing inflation against a backdrop of moderate growth, which has begun to lose some of its momentum.
In recent months, credit spreads for investment-grade and high-yield bonds have tightened, and they have tightened even more this month as inflation readings have fallen, raising hopes that the Federal Reserve’s current hawkish policy will change.
Spreads for investment-grade bonds have decreased by approximately 10 basis points since January and by approximately 37 basis points overall since the beginning of October when viewed as a measure of perceived risk in comparison to holding safer government bonds.
In contrast, spreads for junk-rated debt have decreased by 52 basis points and 116 basis points, respectively, during the same time period.
Analysts and investors, on the other hand, suggested that this clampdown may be coming to an end. Despite a lot of new bond issuance, credit spreads have increased across the board since the beginning of the year and are at tights that have lasted for several months.
Barclays (LON): “This puts the credit market at odds with economic forecasts and the rates market.” A recent note from strategists stated. According to them, bonds with a BBB rating for investment grade in the United States and a CCC rating suggested a 35% chance of recession. In contrast, economists surveyed by Reuters last month predicted a 60% chance of a recession in 2023.
The optimism regarding the macroeconomic outlook was at the heart of the risk-on strategy: A so-called “soft landing” occurs when the Federal Reserve manages price pressures without sending the economy into a recession and is accompanied by signs of a sluggish but resilient economy and easing inflation.
However, some investors are questioning that theory, and price movements in recent days have begun to indicate a degree of caution. Last week, an index of credit default swaps, a derivative that some investors use to either hedge their positions or to short credit, rose for investment grade debt, and spreads on investment grade bonds increased for the first time this year, but only slightly.
While Fed officials predict that interest rates will remain higher for a longer period of time, money markets bet that the Fed will begin cutting rates toward the end of the year. Bruce Clark, senior macro strategist at Informa Global Markets, stated:
“There is a collision waiting to happen between market expectations of a Fed rate cut later in the year and the growing evidence of a global economic recovery that may keep inflation high and might not lead to a reversal in Fed policy.”
According to Dan Krieter, director (FI Strategy) at BMO Capital Markets, corporate spreads do not fully account for the risk of a recession or economic slowdown in which the Fed may not be as accommodative in its policy as in previous downturns, making them appear “rich,” or overvalued.
Krieter stated:
“Even though (companies’) balance sheets are pretty strong here, we’re going to be heading into a recession or strong slowdown, where the Fed’s response function could be different from previous recessions.” “Even though (companies’) balance sheets are pretty strong here,”
In contrast to the previous two recessions, credit markets would have to function independently without the Fed’s massive, extraordinary accommodative policy.
According to Pramod Atluri, principal investment officer on Bond Fund of America and fixed income portfolio manager at Capital Group, corporate bond spreads are still holding for the time being, but the likelihood of significant further tightening has decreased.
Investment-grade bond spreads could tighten by another 20 to 30 basis points in the most optimistic scenario, but they could widen even more if the economic downturn is more severe than anticipated, he added.
Atluri stated that he would consider increasing his allocation to government bonds rather than credit if spreads tightened further because any upside would be further restricted.
