(Bloomberg) — Credit investors got a dose of economic and geopolitical reality this week as hawkish comments from central bank officials about borrowing costs and tensions in the Middle East sent jitters through debt markets.
The pullback was triggered in part by comments from Federal Reserve Bank of New York President John Williams, who said there’s no rush to cut interest rates and it’s possible that economic data could even warrant an increase if inflation persists.
The realization that the interest rate pivot had yet to arrive comes as the US economy continues its strong performance, causing financial conditions to loosen in recent months. As a result, the market isn’t yet showing signals that the central bank has restricted policy enough to begin easing, said Bill Zox, a portfolio manager at Brandywine Global Investment Management.
The return of the higher-for-longer mantra is a headache for insurance companies and pension plans which, flush with cash, sent demand for bonds soaring this year as they tried to lock in yields ahead of the anticipated cuts. Corporates responded by issuing more than $1 trillion of notes globally so far this year, the second-highest level since at least 2013. Now, however, investors are yanking money from high-yield funds and flows into shorter duration high-grade products have slowed dramatically.
Click here to listen to a podcast about how Morgan Stanley thinks credit could be in trouble if the Fed hikes.
For US investment-grade debt, spreads are only edging wider, and demand for many new issues is still strong. But signs of growing caution are clear in credit markets: Spreads on US junk debt have pushed wider after the rise in negative sentiment, and high-yield is poised for the biggest monthly loss on a total return basis since September 2022. It’s a marked reversal of the sense of complacency that earlier this month saw the global perception of risks from credit reach the lowest levels since February of last year, according to a Bank of America Corp. survey of fund managers.
Adding to the problems for policymakers, retaliatory strikes between Israel and Iran have sent oil prices higher, which could fuel inflation. The tensions in the Middle East also risk dampening demand for credit as investors seek havens like Treasuries instead.
Investor Pushback
One area where investors are pushing back is the leveraged loan market. While it continues to see demand, money managers have successfully pushed back on terms sought by issuers in recent days.
Rocket Software Inc. was forced to drop plans for a portable debt structure in recent days after feedback from money managers, according to people with knowledge of the matter. If the trend continues, it’s a potential positive for private credit providers, who have faced renewed competition in recent months from banks.
In Europe, it’s a different story. Traders are pricing around 80 basis points of cuts from the European Central Bank this year and officials have stressed they still plan to cut first in June and don’t need to wait for the Fed.
Still, the volatility this week means more than 70% of bond deals issued in Europe were in the red as of Friday morning in London, hurting retail investors, data compiled by Bloomberg News show.
Back in the US, some junk firms risk being hurt by the tightening in monetary policy.
“If those cuts get pushed out after the election, it could be a challenge for some of the lower-quality floating-rate issuers” who need to refinance, Meghan Robson, head of US credit strategy at BNP Paribas, said in an April 10 interview with the Credit Edge podcast. “That risk is not priced in yet but is something that could come into the debate as we get closer to the June and July timeline.”
Week in Review
On the Move
–With assistance from Michael Msika, Jill R. Shah, Paul Cohen and Dan Wilchins.
More stories like this are available on bloomberg.com
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Published: 21 Apr 2024, 12:48 AM IST