EconomyThe worst is yet to come in the US...

The worst is yet to come in the US debt market, specialists warn

The worst year in history for US corporate bond investors is expected to get even worse, and it’s all the Fed’s fault.

As the central bank raises interest rates at the fastest pace in decades, nearly three-quarters of respondents to the MLIV Pulse survey said tighter monetary policy is the biggest risk facing the corporate debt market. Only 27% were more concerned that corporate bankruptcies will increase in the next six months.

The results underscore the bittersweet outlook for fixed income investors who 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.

For one thing, they don’t think the woes are over, and more than three-quarters of those surveyed expect yields this year to widen to new highs on Treasuries. But at the same time, most expect losses to be relatively limited. They predict that the spread, a key indicator of the extra compensation required for perceived risk, will remain well below levels seen during the March 2020 covid-caused crash or recession triggered by the housing market crash.

Corporate bond yields have risen steadily over Treasuries during the selloff seen in fixed income markets this year. That spread over investment-grade corporate debt reached 160 basis points in July, according to the Bloomberg index, before retreating slightly.

But the relatively modest increases in forward spreads show that investors expect the corporate finance market to avoid the kind of stress that followed the 2007-2009 recession, when investment-grade bond yields rose more than 600 basis points. basic above treasury bonds. In March 2020, that gap reached almost 400 basis points, prompting the Fed to step in to ensure that the lack of available credit did not deal another blow to the economy.

The outlook is likely to reflect the strong position many companies are in after profits surged due to pandemic-related stimulus and two years of rock-bottom interest rates. Despite speculation that the US is headed for a recession, the Labor Department reported Friday that hiring unexpectedly rose in July to a five-month high, underscoring that the economy remains strong despite tightening aggressive monetary policy of the Fed.

Credit risk measures for high-grade, high-yield bonds continued to tighten on Monday. The longest losing streak in a month indicates an easing of concerns about credit prospects.

About 86% of those surveyed said companies are better positioned to weather a recession than they were in 2008. That’s partly because many companies refinanced their debt after the Federal Reserve cut rates in 2020.

Still, strong balance sheets are not expected to be enough to stave off further losses, particularly for speculative-grade bonds, which would be more sensitive to an economic slowdown. Yields are likely to have yet to peak and may rise beyond the nearly 9% high seen in late June, say those surveyed.

Such risk means that some bonds, such as those at the CCC rating level, one of the lowest tiers of junk debt, aren’t as attractive as higher-rated securities, according to John McClain, high-yield portfolio manager at Brandywine. Global Investment Management.

Almost half of the survey participants said they expect equities to outperform corporate debt in the next six months. Just over a third prefer investment-grade debt, more than twice as many who expect better returns from junk bonds. That would mark a break from the pattern seen so far this year, when junk bonds outperformed as shorter maturities and high coupon payments provided a buffer from price declines caused by interest rate hikes. the fed

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